REFINING FRAUD DETECTION TECHNIQUES · In legal theory this is also referred to by a Latin term,...

©2017

REFINING FRAUD DETECTION TECHNIQUES

BAD ACCOUNTING OR CRIMINAL ACT: THE CHALLENGE OF PROVING INTENT

Intent is the element that differentiates bad accounting from criminal fraud. All too often, the

subject is willing to be perceived as stupid instead of being investigated as the perpetrator. This

interactive session will examine the legal elements of fraud, including the types of evidence that

prove intent, then look at actual case documents to show how intent can be proved through

circumstantial evidence. The focus in this session will be to provide you with tools to assess

intent as an element of your cases for a better chance of being pursued by prosecutors.

JANET MCHARD, CFE, CPA, CFF

Founding Partner

McHard Accounting Consulting, LLC

Janet M. McHard is the founding partner of McHard Accounting Consulting, LLC, a firm

specializing in forensic accounting, fraud prevention, and accounting reconstruction. McHard

provides assistance, including expert testimony, in the areas of fraud and forensic accounting.

She also has experience in database management and class action administration. McHard has

received special training in fraud prevention and investigation from the ACFE, the National

Association of Certified Valuation Analysts, and through the University of New Mexico’s

Financial Investigators Certificate Program.

“Association of Certified Fraud Examiners,” “Certified Fraud Examiner,” “CFE,” “ACFE,” and the

ACFE Logo are trademarks owned by the Association of Certified Fraud Examiners, Inc. The contents of

this paper may not be transmitted, republished, modified, reproduced, distributed, copied, or sold without

the prior consent of the author.


28th Annual ACFE Global Fraud Conference ©2017 1

NOTES Even a dog distinguishes between being stumbled over and

being kicked.

― Justice Oliver Wendell Holmes Jr., The Common Law

Introduction

Intent is the element that differentiates bad accounting from

criminal fraud. All too often the suspect is willing to be

perceived as stupid instead of being investigated as the

perpetrator. Intent is often the hardest element to prove in

any crime. And it is the element that moves an accounting

problem from just a training issue to a criminal fraud

scheme.

But intent is a state of mind known only to the suspect. As

a fraud examiner, how do you determine intent?

Intent as an Element of Fraud: Discussion of Legal

Background

Although the actual statutes vary by jurisdiction there are

generally four elements of fraud; the fraudster intentionally

made a material misrepresentation to the victim upon which

the victim relied and as a result of which the victim

suffered damages. So, in general, the four elements of fraud

are:

1. Material misrepresentation is made by fraudster

2. Misstatements made with the intent to deceive

3. The victim relied on the misrepresentation

4. Resulting in damages to the victim

In some cases rather than using the term intent, statutes use

the word knowingly or similar but the result is the same; the

fraudster intended to deceive to victim.

In legal theory this is also referred to by a Latin term, mens

rea, which is a shortened version of the whole Latin phrase

actus reus non facit reum nisi mens sit rea (roughly

https://www.goodreads.com/author/show/432185.Oliver_Wendell_Holmes_Jr_

https://www.goodreads.com/work/quotes/816001



NOTES translated to English “the act is not culpable unless the

mind is guilty”). Mens rea essentially refers to the state of

mind of the suspect at the time the act occurred. Often this

phrase is used this way, “The suspect lacked the mens rea

at the time of the crime.” Meaning the suspect lacked intent

as part of the state of mind at the time of the crime.

[Mens rea] is the state of mind indicating

culpability which is required by statute as an

element of a crime. [Citation omitted] Establishing

the mens rea of an offender is usually necessary to

prove guilt in criminal trial. In doing so, the

prosecution must prove beyond reasonable doubt

that the defendant committed the offense with a

culpable state of mind. Justice Holmes famously

illustrated the concept of intent when he said “even

a dog knows the difference between being stumbled

over and being kicked.”

The mens rea requirement is premised upon the

idea that one must possess a guilty state of mind

and be aware of his or her misconduct; however, a

defendant need not know that their conduct is

illegal to be guilty of a crime. Rather, the defendant

must be conscious of the “facts that make his

conduct fit the definition of the offense.”

— https://www.law.cornell.edu/wex/mens_rea,

accessed on April 9, 2017

As examples, here are some of the statutes from criminal

statutes that apply to various forms of fraud.

2010 Tennessee Code Title 39, Criminal Offenses

Chapter 14, Offenses Against Property Part 1, Theft

39-14-103, Theft of property:

A person commits theft of property if, with intent to

deprive the owner of property, the person

https://en.wikipedia.org/wiki/Culpability

http://cdn.harvardlawreview.org/wp-content/uploads/pdfs/us_v_heredia.pdf

http://scholarship.law.cornell.edu/cgi/viewcontent.cgi?article=2931&context=clr

https://www.law.cornell.edu/supct/cert/13-983

https://www.law.cornell.edu/supct/cert/13-983

https://www.law.cornell.edu/supct/html/92-1441.ZO.html

https://www.law.cornell.edu/supct/html/92-1441.ZO.html

https://www.law.cornell.edu/wex/mens_rea



NOTES knowingly obtains or exercises control over the

property without the owner’s effective consent.

[emphasis added]

— http://law.justia.com/codes/tennessee/2010/title-

39/chapter-14/part-1/39-14-103/, accessed April 9,

2017



39-14-104, Theft of services, A person commits theft of

services who:

(1) Intentionally obtains services by deception, fraud,

coercion, false pretense or any other means to avoid

payment for the services; [emphasis added]

(2) Having control over the disposition of services to

others, knowingly diverts those services to the

person’s own benefit or to the benefit of another not

entitled thereto; or

(3) Knowingly absconds from establishments where

compensation for services is ordinarily paid

immediately upon the rendering of them, including,

but not limited to, hotels, motels, and restaurants,

without payment or a bona fide offer to pay.

—http://law.justia.com/codes/tennessee/2010/title-

39/chapter-14/part-1/39-14-104/, accessed on April

9, 2017



39-14-130, Destruction of valuable papers with intent to

defraud:

(A) Any person who takes or destroys any valuable

papers with intent to injure or defraud shall be

punished as if for theft. If the value of the papers is

not ascertainable, the offense is a Class A

misdemeanor. [emphasis added]

http://law.justia.com/codes/tennessee/2010/title-39/chapter-14/part-1/39-14-103/






NOTES (B) For the purposes of this section, “valuable papers”

includes:

(1) Any bond, promissory note, bill of exchange,

order, or certificate;

(2) Any book of accounts respecting goods, money

or other things;

(3) Any deed or contract in force;

(4) Any receipt, release, or defeasant;

(5) Any instrument of writing whereby any

demand, right or obligation is created,

ascertained, increased, extinguished or

diminished; or

(6) Any other valuable paper writing.


39/chapter-14/part-1/39-14-130/, accessed on April

9, 2017

18 U.S. Code § 1002, Possession of false papers to

defraud United States:

Whoever, knowingly and with intent to defraud the

United States, or any agency thereof, possesses any

false, altered, forged, or counterfeited writing or

document for the purpose of enabling another to

obtain from the United States, or from any agency,

officer or agent thereof, any sum of money, shall be

fined under this title or imprisoned not more than

five years, or both. [emphasis added]

— https://www.law.cornell.edu/uscode/text/18/

1002, accessed on April 9, 2017

18 U.S. Code § 1025, False pretenses on high seas and

other waters:

Whoever, upon any waters or vessel within the

special maritime and territorial jurisdiction of the

United States, by any fraud, or false pretense,

obtains from any person anything of value, or



https://www.law.cornell.edu/uscode/text/18/1002




NOTES procures the execution and delivery of any

instrument of writing or conveyance of real or

personal property, or the signature of any person, as

maker, endorser, or guarantor, to or upon any bond,

bill, receipt, promissory note, draft, or check, or any

other evidence of indebtedness, or fraudulently

sells, barters, or disposes of any bond, bill, receipt,

promissory note, draft, or check, or other evidence

of indebtedness, for value, knowing the same to be

worthless, or knowing the signature of the maker,

endorser, or guarantor thereof to have been obtained

by any false pretenses, shall be fined under this title

or imprisoned not more than five years, or both; but

if the amount, value or the face value of anything so

obtained does not exceed $1,000, he shall be fined

under this title or imprisoned not more than one

year, or both. [emphasis added]

— https://www.law.cornell.edu/uscode/text/18/

1025, accessed on April 9, 2017

18 U.S. Code § 1031, Major fraud against the United

States:

(A) Whoever knowingly executes, or attempts to

execute, any scheme or artifice with the intent—

[emphasis added]

(1) to defraud the United States; or

(2) to obtain money or property by means of

false or fraudulent pretenses,

representations, or promises, in any

grant, contract, subcontract, subsidy,

loan, guarantee, insurance, or other form

of Federal assistance, including through

the Troubled Asset Relief Program, an

economic stimulus, recovery or rescue

plan provided by the Government, or the

Government’s purchase of any troubled





NOTES asset as defined in the Emergency

Economic Stabilization Act of 2008, or

in any procurement of property or

services as a prime contractor with the

United States or as a subcontractor or

supplier on a contract in which there is a

prime contract with the United States, if

the value of such grant, contract,

subcontract, subsidy, loan, guarantee,

insurance, or other form of Federal

assistance, or any constituent part

thereof, is $1,000,000 or more shall,

subject to the applicability of subsection

(c) of this section, be fined not more

than $1,000,000, or imprisoned not more

than 10 years, or both.

—https://www.law.cornell.edu/uscode/text/18/1031,


18 U.S. Code § 1035, False statements relating to health

care matters:

(A) Whoever, in any matter involving a health

care benefit program, knowingly and

willfully—[emphasis added]

(1) falsifies, conceals, or covers up by any

trick, scheme, or device a material fact;

or

(2) makes any materially false, fictitious, or

fraudulent statements or representations,

or makes or uses any materially false

writing or document knowing the same

to contain any materially false, fictitious,

or fraudulent statement or entry, in

connection with the delivery of or

payment for health care benefits, items,

or services, shall be fined under this title




NOTES or imprisoned not more than 5 years, or

both.

—https://www.law.cornell.edu/uscode/text/18/1035,


Although we’ve been discussing the statues specifically

governing fraud you’ll find intent as a required element in

nearly all criminal statutes from arson to murder to white-

collar crime. For example:

Title 39, Criminal Offenses Chapter 13, Offenses

Against Person Part 2, Criminal Homicide

39-13-202, First degree murder:

(A) First degree murder is:

(1) A premeditated and intentional killing of

another; [emphasis added]


39/chapter-13/part-2/39-13-202/, accessed April

20, 2017

Be sure to know what criminal statute applies to your fraud

examination so that you know what elements are necessary

for the crime.

Investigation Techniques for Proving Intent

If intent is a state of mind of the perpetrator, then how do

examiners prove its presence at the time of the crime?

There are really only two ways: (1) direct evidence and (2)

circumstantial evidence.

Direct Evidence

The first and most straightforward is to obtain a written

confession of the crime which includes a statement

from the perpetrator that he/she intended to

misrepresent material facts:






NOTES “I intended to falsify my expense report in order to

obtain funds to which I was not entitled.”

“I intended to falsify the financial statements of my

department so that I could qualify for a bonus that

otherwise I would not have been eligible for.”

“I intended to personally obtain funds from vendors

in exchange for directing contracts to those vendors,

in direct violation of our company’s code of

conduct.”

While getting a confession of intent is the most

straightforward method to prove intent, it does not

routinely occur. If there is a co-conspirator, the co-

conspirator’s statement may provide direct evidence of

intent. This is often seen when a lesser player is given a

plea deal in exchange for testifying against a suspect.

Circumstantial Evidence

The most difficult element to prove in many

fraud cases—fraudulent intent—is usually

proved circumstantially, and necessarily so,

because direct proof of the defendant’s state of

mind, absent a confession or the testimony of a

co-conspirator, is impossible.

—2017 Fraud Examiners Manual, Association of

Certified Fraud Examiners, pp 2-1102 to 2-1103

The second method for proving intent is to show intent

through circumstantial evidence. Per the 2017 Fraud

Examiners Manual, circumstantial evidence is

“evidence that tends to prove or disprove facts in issue

indirectly, by inference.” (2017 Fraud Examiners

Manual, Associates of Certified Fraud Examiners, p. 2-

1102). Also per www.dictionary.law.com,

circumstantial evidence is “evidence in a trial which is

not directly from an eyewitness or participant and

http://www.dictionary.law.com/



NOTES requires some reasoning to prove a fact.”

(http://dictionary.law.com/Default.aspx?selected=191,

accessed on April 10, 2017)

Some examples of circumstantial evidence of intent in a

fraud examination are:

A pattern of transactions that are wrong under

company policy and that benefit the suspect.

Evidence that the suspect received funds as a result

of the transaction.

Evidence that the known associates of the suspect

received benefit from the transactions.

Evidence that the suspect falsified records to cover

up the fraud.

Evidence that the suspect knew the right way to

record or process the transaction but failed to do it

correctly only in certain circumstances, where the

suspect could have benefitted.

The suspect destroyed records which would show

responsibility for the suspected transactions.

Note that there are three common themes running

through these examples.

1. The suspect (or known associates) received benefit

from the ill-gotten goods.

2. The suspect knew better and acted against training

only in certain situations.

3. The suspect falsified or destroyed records regarding

the fraudulent transactions.

Unlike the first method for proving intent where the

suspect confesses to intent, proving intent through

circumstantial evidence is cumulative. By this I mean

that you’ll need multiple examples of circumstantial

evidence of intent to show that, overall, the suspect

intended to hide the fraudulent transactions.

http://dictionary.law.com/Default.aspx?selected=191



NOTES Let’s look at these examples in more detail.

SUSPECT RECEIVED BENEFIT

Some cases lend themselves to circumstantially

proving that the suspect received benefit as proof of

intent. For example, a “ghost employee” scheme

where the fraudster puts false employee information

(the “ghost employee”) into the payroll system with

a direct deposit into the fraudster’s bank account

could be good evidence of benefit to the suspect,

and therefore, evidence of intent. Be careful here,

though, often spouses or children work at the same

employer; make sure there is no other legitimate

employee that could be using the same bank

account information. (Remember, it’s our job to

disprove the fraud, just as much as it is to prove the

fraud.)

Another example where this method of

circumstantial evidence of intent could be used is a

case where the suspect has used company funds to

pay their own personal credit card. Here you’ll need

evidence showing where the payment was applied

(i.e., which credit card account number received the

payment). Often this proof is in the victim’s bank

statement; online payments often show the name of

the card holder or the last few digits of the credit

card account number. Again, you’ll need to be able

to definitively show that the victim company didn’t

have a reason to make a payment to that credit card

account.

POSSIBLE TESTWORK

Test direct deposit information against ACH

information for both payroll and accounts

payable files



NOTES Compare endorsement information to suspect’s

known banking information.

Test bank statement transactions to discern

payments. Electronic payments often show

cardholder. Otherwise work with legal methods

to confirm the cardholder of the credit card

account receiving payments.

Confirm ownership of assets purchased using

funds from the victim company. For real

property purchases, this information may be

located in public records, such as at the local tax

assessor’s office.

SUSPECT ACTED AGAINST TRAINING AND POLICY

Setting aside our quest for intent for a minute, in all

fraud examinations it is important to have criminal

statutes and company policies upon which to base

appropriate behaviors. By this I mean that you

should be able to cite in your fraud examination

report which statutes or policies were violated based

on the evidence you gathered. If the company does

not have an internal policy that was violated, you

may have to rely on best practices. However, having

well-codified internal policies is preferable.

Getting back to our quest for intent, it is not the

violation of company policy that proves intent.

Rather it is the pattern of the violation of the

company policy. If an employee constantly violates

policy by not reconciling the cash account before

the policy-defined deadline, then this would likely

not create circumstantial evidence of intent. On the

other hand, if an employee performs most of the

cash reconciliations within the policy-defined

deadline but fails to reconcile the account from

which they are paying their own expenses, then this

could create circumstantial evidence of intent.



NOTES Likewise, if the suspect gets their supervisor’s

approval for most of the travel vouchers but fails to

get supervisor approval for the two vouchers

submitted that are really their personal vacation, and

not actually business trips, then this could create

circumstantial evidence of intent.

POSSIBLE TESTWORK

Obtain personnel file to determine training

given to suspect.

Personnel file may also contain certifications,

such as a certification that the suspect was given

a copy of the victim company’s code of ethics.

Interview coworkers to determine the nature of

training given.

Look for information indicating that the suspect

received training specifically prohibiting the

violations noted in the fraud examination. These

often appear in the form of documentation of

adverse human resources action for progressive

discipline.

SUSPECT DESTROYED OR FALSIFIED RECORDS

When you are gathering documents as part of your

fraud examination, carefully look for any evidence

that the suspect destroyed or falsified records

regarding the defalcation. You should also look for

any pattern of destruction or falsification of records.

If you have suspicions regarding a certain vendor

and there is no file for that vendor, this should be

noted in your examination notes. If you suspect that

vendor names might have been changed in the

accounting software after the checks were processed

and the invoices for those payments are missing

from the vendor file, get the canceled checks. It is



NOTES possible the vendor name was changed after the

check was written. If you can determine who is

responsible for the change of vendor name, such as

through entries on the audit trail for the software,

this would be circumstantial evidence of intent.

Again, you’re looking for patterns. If vendors are

changed frequently, by many users of the

accounting system, this would not likely be

circumstantial evidence of intent. However, if the

suspect does this only for certain payments, this

could be circumstantial evidence of intent.

POSSIBLE TESTWORK

Look for evidence of modification of

transactions that represent violations found in

the fraud examination. This might include

correction fluid, erasures on original documents,

or evidence the original document has been

“washed” to remove the original text.

Confirm that bank documents are unaltered by

obtaining copies of bank statements, canceled

checks, and deposit slips directly from the

financial institution. Both Adobe and Photoshop

make it easy for fraudsters to alter electronically

stored documents. Consequently, before you

finalize your opinions it is wise to obtain copies

of key documents from third parties (banks,

vendors) to confirm that documents have not

been altered. (Tip: This is important to ensure

that your contact at the victim organization is

not involved in the scheme too!)

Download the audit trail from the accounting

software system and look for changes or edits

by the suspect. Then look at how those

changes/edits impact the financial reporting of

the transactions.



NOTES Conclusion

As you conduct a fraud examination be sure to understand

the legal concept of intent and what evidence of intent

might look like during the examination. Be sure to look at

both financial and non-financial documents and

information as sources to help you determine whether

intent exists. Also, keep in mind that intent may well be

proved by comparing documents from within the

organization to the same document, without modifications

by the fraudster, held by third parties outside the

organization.

Most folks would rather be stupid rather than criminals;

intent is the difference between the two. And remember, “it

isn’t the fraud that gets ’em; it’s the cover-up that gets

’em.”

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