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The Importance of a Fraud &
Misconduct Strategy
NYSICA
March 25, 2004
Presented by:
Christopher J. Rosetti, Partner
BST Advisors, LLC
Forensic Accounting and Investigative Services
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AGENDA:
Introduction
Tone at the Top
Code of Conduct Effective Fraud and Misconduct
Strategy
Best Practices Grant Administration
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Unknown:
´Confidence and trust are like amortal·s need for air. When therequired good is present, it·s nevernoticed. When it·s missing, it·s all that·s
noticedµ
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Public Misconduct
XYZ Agency Fails to Curb Fraud
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Audit Risks for thePublic Sector
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The Principal Types
of Fraud
Bribery Conflicts of Interest
Theft of Money or Property
Breach of Fiduciary Duty
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Bribery
Giving or receiving a thing of value toinfluence a business decision without the
consent or knowledge of the principal.
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Conflicts of Interest
An agent taking an interest in a
transaction that is actually or potentiallyadverse to the principal without full andtimely disclosure to the principal
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Theft of Money or Property
EmbezzlementThe defendant took or converted, without theknowledge or consent of the organization, money
or property of another that was properlyentrusted to the defendant.
LarcenyTaking and carrying away money or property of
another, without the consent of the owner, withthe intent to permanently deprive the owner of itsuse or possession.
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Breach of FiduciaryDuty The principal fiduciary duties are loyalty and care.
Duty of Loyalty requires that the employee actsolely in the best interest of the employer, free of
any self dealing, conflicts of interest, or other abusefor personal advantage.
Duty of Care requires that persons in a fiduciaryrelationship must conduct business affairs
prudently with the skill and attention normallyexercised by a person in similar positions.
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Many technological advances reduce the
audit trail and facilitate perpetration ofsophisticated computer crimes which
siphon funds to fictitious or unauthorizedaccounts.
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Internal Control Facts
Internal control starts with a strong controlenvironment:
� Management has the proper attitude andoperating style
� Management is the owner of internal control
� Internal controls are built into the business
process
Adapted from the 12/03 issue of Financial & Audit Solutions
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Is there an ethics/compliance program in place?
Has it been designed to satisfy leading governmental models (e.g., federal sentencing guidelines)?
Has it been implemented throughout theorganization, are there indicators that it isoperating as intended (e.g., frequency oftraining, volume of hotline calls, consistency of
discipline)?Has it been effective in achieving compliance
with the organization·s ethical and legalobligations?
Tone at the Top
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Fraud and
misconduct
reporting and response
Strong corporate culture,
values & ethics
Effective
Compliance Program
Fraud\misconduct
awareness
Effective personnel
policies
An Effective Fraud and
Misconduct Strategy
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An Effective Fraud and
Misconduct Strategy (continued)
Strong Corporate Culture with supporting
Ethics and Values
Credible leadership commitment
Corporate Values Statement
Clear and specific Code of Conduct
�Define acceptable and unacceptable behavior
�Address potential ethical dilemmas
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Effective
Ethics/ Code of Conduct
Helps prevent misconduct
Detects violations and provides and earlywarning system
Timely and responsible actions help avertprosecution
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Code of Conduct Checklist
- Use of equipment (telephone, vehicle,
photocopiers, scanner, supplies, creditcards)
- Use of the internet during work hoursand/or for non-work related reasons.
- Acceptance of gifts from vendors,suppliers and contractors
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Code of Conduct Checklist(continued)
5. Conflicts of interest (sign form annually):Having direct or indirect, financial or
otherwise, in any transaction or activitythat conflicts with the proper dischargeof the employee·s duties.
6. Outside employment or dual
employment7. Confidential information
8. Intellectual property
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Code of Conduct Checklist(continued)
9. Use of official position to secure
unwarranted privileges orexemptions
10. On-site weapons
11. Restricting competition
12. Computer security13. Time and attendance
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Code of Conduct Checklist(continued)
14. Exercising common sense
15. Expense reimbursements16. Disparaging contractors
17. Illegal betting or gambling
18. Destruction of organizational records
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Reasons for Failure
The message is not supported by seniormanagement
The ethics policy/code of conduct doesnot provide practical guidance or example
Regular training is not provided
Compliance officer is overburden withother matters
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Reasons for Failure (continued)
People are not aware of the hotline
nor is it used Corrective actions are not initiated
Compliance is not monitored and anannual report is not issued
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Periodically Reinforce Values
Annual training
Annual conflicts of interest affidavit Posted flyers
Reminders with W-2s
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Periodically Reinforce Values(continued)
Weekly or monthly email reminders
about policies Code of conduct and ethics policy
posted on intranet
Posters advertising anonymousreporting mechanism
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An Effective Fraud and
Misconduct Strategy (continued)
Effective Personnel Policies
Recruitment screening
Vacation policies
Appraisal system and counseling policies
Employee attitude surveys
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Effective Personnel Policies
Recruitment screening� Verify identity
� Check qualifications, names of schools
� Probe employment gaps� Obtain references
Vacation policies and work patterns� Enforce vacations
Appraisal and counselingEmployee attitude surveys
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Effective Personnel Policies(continued)
Background checks
Social security number verification
OFAC check
Media checks
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An Effective Fraud andMisconduct Strategy
Fraud\misconduct awareness Typical fraud risks
Common indicators
Behavioral issues
Control benchmarking
Reporting fraud suspicions
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Quality of Your Fraud and
Misconduct Strategy Score each of these on a 1 to 10 scale.
1. What is the quality of your anti-fraud andmisconduct strategy?
2. Is responsibility for managing fraud andmisconduct risk well defined?
3. How clear are reporting channels for reportingsuspicions of fraud or misconduct?
4. Are there clear protections for those reportingfraud or misconduct?
5. How effective is your fraud and misconductawareness program?
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Quality of Your Fraud and
Misconduct Strategy Score each of these on a 1 to 10 scale.
1. How effective is your recruitment screening process?
2. How developed is the understanding of fraud andmisconduct risks facing your organization?
3. How have you matched these risks to controls to seehow they are managed?
4. How effectively does your organization learn fromfraud and misconduct incidents?
5. How aware of fraud and misconduct are head officeand regional personnel?
W hat is the total score?
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Quality of Your Fraud and
Misconduct Strategy (continued)
How did your organization rate?
�90 to 100 points = Strong� 80 to 89 points = Effective
� 70 to 79 points = Needs Improvement
� 60 to 69 points = High Risk� Below 60 points = Very High Risk
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Indications of Low Fraud and
MisconductAwareness
No systems on fraud or
misconduct, it is not a
regular agenda item.
Do not believe there
is a structured way
of assessing risk.
No forum where the
subject of the
meeting is fraud and
misconduct risk.
People in the businessdo review fraud and
misconduct, but only in
a passive way.
The risk section isconsidered a cost
driver.I see the potential fraud
risks as nil to small.
The organization has
not considered fraud
risks. It trusts its
employees.
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An Effective Fraud and
Misconduct Strategy (continued)
Effective Fraud and Misconduct Reporting and Response Program
Fraud and misconduct reporting channels
Whistler blower protection and non-retaliation policy
Fraud and misconduct response plans
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Effective Fraud and
Misconduct Reporting and Response
Questions� Why investigate?
� When to investigate?
� What to investigate?� Who should investigate?
�How to conduct investigation?
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Effective Fraud and Misconduct
Reporting and Response (continued)
Importance of fraud risk management Every organization should have a documented anti-fraud
strategy and corporate integrity program. At a minimum itshould include:
� Agency·s stance on fraud and other breaches ofcompany·s policies and ethical code
� To whom and how should suspicions of fraud ormisconduct be reported
� What will be done and by whom in the case that fraud orother breaches are suspected
� Employee rights - including limitations on expectations ofprivacy and company·s rights to gain access and searchall work areas
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Effective Fraud and Misconduct
Reporting and Response (continued)
Why investigate?
�It·s your duty
�It·s the right thing
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Effective Fraud and Misconduct
Reporting and Response (continued)
Why it·s your duty
�Organizations have no choice» 1991 Sentencing Guidelines
» Prevalence of government voluntary
disclosure programs» Administrative and court rulings
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Effective Fraud and Misconduct
Reporting and Response (continued)
Why it·s the right thing� Best practice
» Conducting internal investigations is the norm ratherthan the exception
» 94% of companies responding to 1998 Fraud Survey saidthat conducting an investigation was the leadingresponse to the discovery of fraud
» Assists organizations in determining the extent of
potential civil or criminal liability» Assists in determining facts, available defenses, and
appropriate response
» Assist in negotiating a favorable resolution or avoidingan intrusive government investigation
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Effective Fraud and Misconduct
Reporting and Response (continued)
Why it·s the right thing Bottom Line protection
Deterrence Given the cost of fraud, a fraud response is essential
Recovery
Asset tracing and recovery
Insurance coverage
Public relations
Permits affirmative, proactive communications strategy
Avoids charge of cover up
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Effective Fraud and Misconduct
Reporting and Response (continued)
When to investigate
� Knowledge of information suggesting reasonablepossibility that a third party and/or an employeemight have engaged in wrongful conductexposing the organization to risk of criminalliability, substantial monetary loss or damage,
injury to its reputation, or other type of significantharm
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Effective Fraud and Misconduct
Reporting and Response (continued) When to investigate
� Timing
» Decision should be made as soon as possible
» Advantages of early start
Greater ability to develop appropriate response and defense Increases likelihood that corporations can gather information
and interview employees before government
Enables corporations to qualify for credit for full cooperationunder Sentencing Guidelines
» Importance of Fraud and Misconduct Response Plan as part of a
compliance program Corporation needs to be prepared in advance to insure
prompt and appropriate response
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Effective Fraud and Misconduct
Reporting and Response (continued)
What to investigate
� Fraud ² Internal or external» Falsification of financial data
» Misappropriation of assets
» Theft or embezzlement
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Effective Fraud and Misconduct
Reporting and Response (continued)
What to investigate
�Violations of organization policy» Examples Conflicts of interest
Policies regarding giving or receiving gifts
Waste/Mismanagement Mishandling of confidential or proprietary
information
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Effective Fraud and MisconductReporting and Response (continued)
Who should investigate� Chief of internal compliance (Integrity Officer)
» An individual should be designated by each organization towhom all information regarding potential misconduct should
be reported» Responsibility
To receive reports of fraud or misconduct
To conduct initial evaluation (refer to either HR or GC)
� General Counsel
» Responsibility
To determine seriousness of allegation To determine scope and direction of investigation
To consult and advise other relevant executives
To determine the need for retention of outside counsel
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Effective Fraud and Misconduct
Reporting and Response (continued)
Who should investigate
�All internal investigations shouldalways be directed by counsel
�Principal reason:» Permits invocation of privilege to protect
the confidentiality of internalinvestigative results
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!!!Assume all Cases
W ill End in Litigation!!!
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Findings Could Result in:
Civil Litigation
Criminal Litigation No Action
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False Imprisonment Occurs
W hen There Is
An intent to confine
An act resulting in confinement Consciousness of confinement
or resulting harm.
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Effective Fraud and MisconductReporting and Response (continued)
H ow to investigate� Develop Investigative Hypothesis
» Theory of fraud or misconduct - Extent and elements
» Who may be involved
» Where is the evidence likely to be found Documents
Witnesses
Individual computers
Transportable media
Network servers
� Constantly refine and re-examine
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Effective Fraud and MisconductReporting and Response (continued)
H ow to investigate� Develop Work Plan
» Consistent with theory of fraud or misconduct» Identify documents to be examined
» Procedures to be followed
Examples Document examination and verification
Types of analysis
Manual reviewGap, variance
Reconciliation
Sorting and comparisons
Trend
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Effective Fraud and Misconduct
Reporting and Response (continued)
H ow to investigate� Identify potential sources of electronic or voice information
and data
� Examples» PCs» Laptops» Transportable media» Network servers» Voice-mails
» Emails» Recorded conversations ² e.g. securities trading» Video tapes
� Procedures and tools to be used to retrieve electronic and voicedata
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Effective Fraud and Misconduct
Reporting and Response (continued)
H ow to investigate�Identify individuals to be interviewed
» Inside organization
» Outside organization ² e.g. vendors
�Develop interview menus» Order of interviews
» Questions to be asked
�Identify other investigative procedures» Public database searches
» Data analysis
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Effective Fraud and Misconduct
Reporting and Response (continued)
Res pecting employee rights
Employee Rights include:� Contractual Right
Example» If employee is a member of a union, union contract or
collective bargaining agreement may contain restrictions
on investigation procedures� Whistleblower laws
» Protect employees who report misconduct togovernment from retaliatory action
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An Effective Fraud and MisconductStrategy (continued)
Effective Compliance Program Standards and procedures that are reasonably
capable of preventing fraud and misconduct
High-level oversight
Due care in delegating discretionary authority
Effective communication of standards and procedures
(Training)
Monitoring and auditing of compliance program
Enforcement of program through discipline
Appropriate response upon notification of wrongdoing
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Federal Sentencing Guidelines for
an Effective Compliance ProgramHigh level oversight
Standards of conduct
Communications and trainingCompliance auditing and monitoring
Pre-employment screening
Enforcement of standards and disciplinaryactions
Corrective actions taken
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Fraud and misconduct
Reporting and response
Culture, values & ethics
Effective
Compliance Program
Reporting channels
Whistle blower protections
Response plans
Typical fraud risks
Common indicators
Behavioral issues
Control benchmarking
Reporting fraud
suspicions
Values statement
Code of Conduct
Defining acceptable and
unacceptable
Addressing ethicaldilemmas
Standards and procedures High-level oversight
Delegation due care
Training
Monitoring and Auditing
Discipline
Appropriate response
Fraud\ misconduct
awareness
Effective personnel policies
Recruitment screening
Vacation policies
Appraisal and counseling
Employee attitude surveys
An Effective Fraud and
Misconduct Strategy (continued)
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Objectives of a Fraud
Response Plan
Provide a conduit for whistleblowers
Identify internal affairs personnel Outline the manner in which all reviews
should proceed
Prevent further loss
Identify high risk areas
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Objectives of a Fraud
Response Plan
Respond quickly
Secure evidence Identify parties involved
Identify loss remedies
Identify specialists
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Best Practices (continued)
Third party receives complaints aboutbilling, collections and payments.
Clerk who issued bills, collected cash andreceived complaints misappropriated$357,000 via a lapping scheme involving
4,000 water utility customers.
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Best Practices (continued)
Bonding employees:
Estimate the amount and add a cushion(Nobody steals small amounts)
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Best Practices (continued)
Telephone Audits: www.google.com.Type in telephone number and hit
google search. 900 calls by mailman during lunch
Go out an let people know what your
doing. They don·t know who you·relooking at.
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Best Practices (continued)
Checking inventory annually to identifyexcess inventory
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Right to Audit
Obtaining the right:
Right to Audit Agreement -
on the back of purchase
order or procurement form
Right to Audit Clause in a
Contract - include language
in the body of the contract
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Best Practices (continued)
Compliance audits of purchasingpolicies (kickbacks and embezzlements)
Written policies and procedures
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The Value of Nothing
No telephone number is master vendor
file Telephone number is the same digit, i.e.
all 9·s
No address No contact person of fed ID #
P
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GrantAdministration
Right to audit
Purchasing vs. leasing
Tel Calls
Travel
Food Vendors
Subcontracts
Employees
P
? ?? ???
???? ??
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Questions?Chris Rosetti
BST Advisors, LLC26 Computer Drive WestAlbany, New York 12205
Tel: 518-459-6700 / 800-724-6700 Fax 518-459-8492
www.bstadvisors.com