Spring 2003 Topic 7

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ACCT 410/610: Fraud Examination: 

ACCT 410/610: Fraud Examination An NDSU course developed & taught by: Thomas A. Buckhoff, Ph.D., CFE, CPA Topic 7: February 27, March 4, 2003

Quote for the Day: 

Quote for the Day “With the specific item method of proof, the investigator searches for a specific financial transaction to investigate….A direct link is established between the suspect, the financial transaction and the illegal activity.” Source: IRS text, p. 147.

Agenda for Today: 

Agenda for Today Criminal of the day Sources of information Exercise #9 Theft Act Investigative Methods Methods of proof Exercise #10

Criminal of the Day: 

Criminal of the Day In-Class Video: Michael Fulton, Bank President Embezzled $3 million in 3 years by charging the embezzled funds to fixed asset accounts

The Internet: 

The Internet The Internet contains a broad range of public information which can be of value to the financial investigator.

The Internet: 

The Internet KnowX Public Records Search Software knowx.com USSearch.com 1800ussearch.com Employee screening www.screennow.com

Banks as Sources of Information: 

Banks as Sources of Information Banks help investigators trace the flow of money

Bank Transactions: Account: 

Bank Transactions: Account Directly related to money flow: Withdrawals Deposits Credit/debit memos Bank statements are “gold mines” for financial investigators!

Bank Transactions: Non-Account: 

Bank Transactions: Non-Account Not directly related to money flow: Currency transactions Bank checks Loans Wire transfers Safe deposit boxes Bank credit cards

Exercise #9: 

Exercise #9 The purpose of this exercise is to familiarize you with bank records. With your group, complete the Richard Wright Embezzlement Case.

Exercise #9, Part 1: 

Exercise #9, Part 1 Adjusted balance: $2,636.13

Known Sources of Income: 

Known Sources of Income

Part 2: Items to Investigate: 

Part 2: Items to Investigate The following deposits do not seem to be tied to monthly income: 1/3/02 for $3,000. 1/18/02 for $750 cash. Total deposits seem high for known sources of income. Trace where money came from.

Part 2: Items to Investigate: 

Part 2: Items to Investigate Total monthly expenses seem higher than monthly income: Examine canceled checks to see how money is being spent. Why were two power bills paid? Does suspect own another property? Examine previous bank statements to determine a trend in deposits.

Conducting Fraud Examinations: 

Conducting Fraud Examinations Understand controls over cash flows Identify weaknesses Generate fraud theories Collect and evaluate evidence Estimate losses Report findings Assist in filing charges and/or claims

Types of Fraud Schemes: 

Types of Fraud Schemes On-Book Schemes Direct, documentary evidence can be obtained to prove fraud Off-Book Schemes Indirect, circumstantial evidence needed to prove fraud

Investigating Off-Book Fraud Schemes: 

Investigating Off-Book Fraud Schemes Methods: Financial statement analysis Surveillance Invigilation Interviews

Theft Act Investigative Methods: 

Theft Act Investigative Methods Surveillance and covert operations Observing and recording various events which form a part of the fraud. Invigilation Purpose is to establish a fraud-free profile. Physical evidence Includes tangible evidence such as stolen inventory.

Quote for the Day 2: 

Quote for the Day 2 Invigilation is a theft act investigative technique in which controls are made so strict that opportunities to commit fraud are virtually eliminated, and a fraud-free profile can be established. Source: Fraud text, p. 148.

Invigilation: 

Invigilation Can be very effective in determining the existence of fraud. Example: “The Southern”

Case study: The Southern: 

Case study: The Southern Business serves food and drinks along with live entertainment. Owner is not satisfied with its profitability. Engages consultants to look for ways to improve profitability.

The Southern: Financial Analysis : 

The Southern: Financial Analysis

The Southern: Understanding Cash Flows: 

The Southern: Understanding Cash Flows Customer pays server cash for food/drinks. Server pays cash to bartender who dispenses drinks. Bartender “rings up” the order and puts cash in drawer. Manager counts cash at end of night and makes deposit.

The Southern: Develop Fraud Theories: 

The Southern: Develop Fraud Theories Group Discussion: How could the manager, servers, and/or bartenders steal from the Southern? How could you “test” your theory to see if employees are stealing?

The Southern: Fraud Theories: 

The Southern: Fraud Theories Manager steals part of deposit. Servers and bartenders “skim” cash received from customers. Employees allow friends to have drinks for free. Various cash disbursement schemes.

The Southern: Testing Fraud Theories: 

The Southern: Testing Fraud Theories Financial statement analysis and review of canceled checks. Undercover surveillance. Invigilation. Fraud assessment questioning of all employees. Confront target in admission-seeking interview.

The Southern: Invigilation Results: 

The Southern: Invigilation Results

The Southern: Admission-seeking Interview: 

The Southern: Admission-seeking Interview During the fraud assessment interviews, several employees “fingered” the manager as the primary fraudster. Undercover surveillance confirms manager is stealing. Manager confesses in admission-seeking interview.

The Southern: Epilogue: 

The Southern: Epilogue Several employees either quit or are terminated. Evidence is turned over to law enforcement for prosecution. Employee dishonesty insurance claim is filed. Many changes are made to business process.

Exercise #10: Example of a Fictitious Vendor Scheme: 

Exercise #10: Example of a Fictitious Vendor Scheme Complete the Double Trouble Case Study on p. 7.3 of the Student Workbook

Instructions: Part 1: 

Instructions: Part 1 Read the newspaper article on p. 7.3. How do you think this fraud was discovered? After considering this question, see next slide for answer.

Part 1: Answer: 

Part 1: Answer Investigative procedure: Matched payments for invoices to receiving documents. Finding: No receiving documents existed for numerous invoices approved for payment by Lisa Chaffey.

Instructions: Part 2: 

Instructions: Part 2 Review pages 7.4, 7.5, and 7.6. Identify items that support the fraud theory that Fairmont Co. is a fictitious vendor. The case began with the money order. The other documents were among hundreds of items seized from the Chaffey’s residence.

Part 2: Answer: 

Part 2: Answer A legitimate vendor would issue a company check rather than use a money order. Fictitious vendors generally list only a P.O. Box address. Paid for an answering service with another money order. Legitimate vendors rarely, if ever, use an answering service.

Instructions: Part 3: 

Instructions: Part 3 Identify the investigative steps you would take to resolve resolve this case. The total amount of the fraud loss was at least $44,000 as given on p. 7.3.

Part 3: Answer: 

Part 3: Answer Investigative steps: Interview various people. Examine phone directories. Match invoices to receiving documents. Review suspect payments. Trace bogus invoices to person who approved them. Search Chaffey’s garbage. Search Chaffey’s residence.

Reviewing Suspect Payments: 

Reviewing Suspect Payments Review canceled checks Trace canceled checks to supporting documentation and investigate: Discrepancies Unnumbered or sequentially unusual invoices Altered or photocopied documents

Fraudwise: 

Fraudwise Specializing in fraud detection, investigation, and prevention consulting services Senior Consultant: Thomas Buckhoff, Ph.D., CFE, CPA 2974 Southgate Drive Fargo, ND 58103-3524 701-231-8512 www.fraud-wise.com