Category Archives: Fraud Risk Assessment

Charting the Road Ahead

There are a number of good reasons why fraud examiners and forensic accountants should work hard at including inclusive, well written descriptions of fraud scenarios in their reports; some of these reasons are obvious and some less so. A well written fraud report, like little else, can put dry controls in the context of real life situations that client managers can comprehend no matter what their level of actual experience with fraud. It’s been my experience that well written reports, couched in plain business language, free from descriptions of arcane control structures, and supported by hard hitting scenario analysis can help spark anti-fraud conversations throughout the whole of a firm’s upper management.

A well written report can be a vital tool in transforming that discussion from, for example, relatively abstract talk about the need for an identity management system to a more concrete and useful one dealing with the report’s description of how the theft of vital business data has actually proven to benefit a competitor.

Well written, comprehensive fraud reports can make fraud scenarios real by concretely demonstrating the actual value of the fraud prevention effort to enterprise management and the Board. They can also graphically help set the boundaries for the expectations of what management will expect the prevention function to do in the future if this, or similar scenarios, actually re-occur. The written presentation of the principal fraud or loss scenario treated in the report necessarily involves consideration of the vital controls in place to prevent its reoccurrence which then allows for the related presentation of a qualitative assessment of the present effectiveness of the controls themselves. A well written report thus helps everyone understand how all the control failures related to the fraud interacted and reinforced each other; it’s, therefore, only natural that the fraud examiner or analyst recommend that the report’s intelligence be channeled for use in the enterprise’s fraud and loss prevention program.

Strong fraud report writing has much in common with good story telling. A narrative is shaped explaining a sequence of events that, in this case, has led to an adverse outcome. Although sometimes industry or organization specific, the details of the specific fraud’s unfolding always contains elements of the unique and can sometimes be quite challenging for the examiner even to narrate. The narrator/examiner should especially strive to clearly identify the negative outcomes of the fraud for the organization for those outcomes can sometimes be many and related. Each outcome should be explicitly explicated and its impact clearly enumerated in non-technical language.

But to be most useful as a future fraud prevention tool the examiner’s report needs to make it clear that controls work as separate lines of defense, at times in a sequential way, and at other times interacting with each other to help prevent the re-occurrence of the adverse event. The report should attempt to demonstrate in plain language how this structure broke down in the current instance and demonstrate the implications for the enterprise’s future fraud prevention efforts. Often, the report might explain, how the correct operation of just one control may provide adequate protection or mitigation. If the controls operate independently of each other, as they often do, the combined probability of all of them failing simultaneously tends to be significantly lower than the probability of failure of any one of them. These are the kinds of realities with the power to significantly and positively shape the fraud prevention program for the better and, hence, should never be buried in individual reports but used collectively, across reports, to form a true combined resource for the management of the prevention program.

The final report should talk about the likelihood of the principal scenario being repeated given the present state of preventative controls; this is often best-estimated during discussions with client management, if appropriate. What client management will truly be interested in is the probability of recurrence, but the question is actually better framed in terms of the likelihood over a long (extended) period of time. This question is best answered by involved managers, in particular with the loss prevention manager. If the answer is that this particular fraud risk might materialize again once every 10 years, the probability of its annual occurrence is a sobering 10 percent.

As with frequency estimation, to be of most on-going help in guiding the fraud prevention program, individual fraud reports should attempt to estimate the severity of each scenario’s occurrence. Is it the worst case loss, or the most likely or median loss? In some cases, the absolute worst case may not be knowable, or may mean something as disastrous as the end-of-game for the organization. Any descriptive fraud scenario presented in a fraud report should cover the range of identified losses associated with the case at hand (including any collateral losses the business is likely to face). Documented control failures should always be clearly associated with the losses. Under broad categories, such as process and workflow errors, information leakage events, business continuity events and external attacks, there might have to be a number of developed, narrative scenarios to address the full complexity of the individual case.

Fraud reports, especially for large organizations for which the risk of fraud must always remain a constant preoccupation, can be used to extend and refine fraud prevention programs. Using the documented results of the fraud reporting process, report data can be converted to estimates of losses at different confidence intervals and fed to the fraud prevention program’s estimated distributions for frequency and severity. The bottom line is that organizations of all sizes shouldn’t just shelve their fraud reports but use them as vital input tools to build and maintain the ongoing process of fraud risk assessment for ultimate inclusion in the enterprise’s loss prevention and fraud prevention programs.

Sniffing it Out

The first Virginia governor I worked for directly was John Dalton, who was fond of saying that his personal gauge for ethically challenged behavior was the smell test, i.e., did any proposed action (and its follow-on implications) have the odor of appropriateness. Philosophical theories provide the bases for most useful practical decision approaches and aids, although a majority of seasoned executives are unaware of how and why this is so. Whatever the foundation of the phenomena may be, most experienced directors, executives, professional accountants (and governors) appear to have developed tests and commonly used rules of thumb that can be used to assess the ethicality of decisions on a preliminary basis.

If these preliminary tests give rise to concerns, most think a more thorough analysis should be performed. It is often appropriate (and quite common in practice) for subordinate managers and other employees to be asked to check a proposed decision in a quick, preliminary manner to see if an additional full-blown ethical or practicality analysis is required. These quick tests are often referred to as sniff tests. If any of these quick tests are negative, employees are asked to seek out someone like the corporate counsel or an ethics officer (if there is one) for consultation, or to personally perform a full-blown analysis of the proposed action. This analysis is usually retained, and perhaps even reviewed by upper management.

Some of the more common sniff tests employed by managers with whom I’ve worked are:

–Would I be comfortable if this action or decision were to appear on the front page of a national newspaper tomorrow morning?
Will I be proud of this decision?
Will my mother and father be proud of this decision?
Is this action or decision in accord with the corporation’s mission and code?
Does this feel right to me?

Unfortunately, although sniff tests and commonly used ethical rules of thumb are based on ethical principles as popularly conceived and are often useful, they rarely, by themselves, represent anything approaching a comprehensive examination of the confronting decision and therefore can leave the individuals and organization(s) involved vulnerable to making a challengeable choice. For this reason, experts advise that more comprehensive techniques of evaluation should be employed whenever a proposed decision is questionable or likely to have significant consequences. Analysis of specific sniff tests and the related heuristics reveals that they usually focus on a fraction of the comprehensive set of criteria that more complete forms of analysis examine.

Traditionally, an accepted business school case approach to the assessment of a corporate decision and the resulting action has been to evaluate the end results or consequences of the action. To most businesspeople, this evaluation has traditionally been based on the decision’s impact on the interests of the company’s owners or shareholders.

Usually these impacts have been measured in terms of the profit or loss involved, because net profit has been the measure of well-being that shareholders have wanted to maximize. This traditional view of corporate accountability has been modified over the last two decades in two ways. First, the assumption that all shareholders want to maximize only short-term profit appears to represent too narrow a focus. Second, the rights and claims of many non-shareholder groups, such as employees, consumers/clients, suppliers, lenders, environmentalists, host communities, and governments that have a stake or interest in the outcome of the decision, or in the company itself, are being accorded an increased status in corporate decision making.

Modern corporations are increasingly declaring that they are holding themselves self -accountable to shareholders and to non-shareholder groups alike, both of which form the set of stakeholders to which the company pledges to respond. It has become evident (look at the Enron example) that a company cannot reach its full potential, and may even perish, if it loses the support of even one of a select set of its stakeholders known as primary stakeholders.

The assumption of a monolithic shareholder group interested only in short-term profit is undergoing modification primarily because modem corporations are finding their shareholders are to an increasing degree made up of persons and institutional investors who are interested in longer-term time horizons and in how ethically individual businesses are conducted. The latter, who are referred to as ethical investors, apply two screens to investments: Do the investee companies make a profit in excess of appropriate hurdle rates, and do they strive to earn that profit in a demonstrably ethical manner?

Because of the size of the shareholdings of mutual and pension funds, and of other types of institutional investors involved, corporate directors and executives have found that the wishes of ethical investors can be ignored only at their peril. Ethical investors have developed informal and formal networks through which they inform themselves about corporate activity, decide how to vote proxies, and how to approach boards of directors to get them to pay attention to their concerns in such areas as environmental protection, excessive executive compensation, and human rights activities in specific countries and regions. Ethical investors as well as other stakeholder groups, tend to be increasingly unwilling to squeeze the last ounce of profit out of the current year if it means damaging the environment or the privacy rights of other stakeholders. They believe in managing the corporation on a broader basis than short-term profit only. Usually the maximization of profit in a longer than one-year time frame requires harmonious relationships with most stakeholder groups based on the recognition of the interests of those groups.

A negative public relations experience can be a significant and embarrassing price to pay for a decision making process that fails to take the. wishes of stakeholder groups into account. Whether or not special interest groups of private citizens are also shareholders, their capacity to make corporations accountable through social media is evident and growing. The farsighted executive and director will want these concerns taken into account before offended stakeholders have to remind them.

Taking the concerns or interests of stakeholders into account when making decisions, by considering the potential impact of decisions on each stakeholder, is therefore a wise practice if executives want to maintain stakeholder support. However, the multiplicity of stakeholders and stakeholder groups makes this a complex task. To simplify the process, it is desirable to identify and consider a set of commonly held or fundamental stakeholder interests to help focus analyses and decision making on ethical dimensions; stakeholder interests such as the following:

1.Their interest(s) should be better off as a result of the decision.
2. The decision should result in a fair distribution of benefits and burdens.
3. The decision should not offend any of the rights of any stakeholder, including the decision maker, and ..
4. The resulting behavior should demonstrate duties owed as virtuously as expected.

To some extent, these fundamental interests have to be tempered by the realities facing decision makers. For example, although a proposed decision should maximize the betterment of all stakeholders, trade-offs often have to be made between stakeholders’ interests. Consequently, the incurrence of pollution control costs may be counter to the interests of short-term profits that are of interest to some current shareholders and managers. Similarly, there are times when all stakeholders will find a decision acceptable even though one or more of them, or the groups they represent, may be worse off as a result.

In recognition of the requirement for trade-offs and for the understanding that a decision can advance the well-being of all stakeholders as a group, even if some individuals are personally worse off, this fundamental interest should be modified to focus on the well-being of stakeholders rather than only on their betterment. This modification represents a shift from utilitarianism to consequentialism. Once the focus on betterment is relaxed to shift to well-being, the need to analyze the impact of a decision in terms of all four fundamental interests becomes apparent. It is possible, for example, to find that a proposed decision may produce an overall benefit, but the distribution of the burden of producing that decision may be so debilitating to the interests of one or more stakeholder groups that it may be considered grossly unfair. Alternatively, a decision may result in an overall net benefit and be fair, but may offend the rights of a stakeholder and therefore be considered not right. For example, deciding not to recall a marginally flawed product may be cost effective, but would not be considered to be right if users could be seriously injured. Similarly, a decision that does not demonstrate the character, integrity, or courage expected will be considered ethically suspect by stakeholders.

A professional CFE can use an assessment of our client organization’s stakeholder ethical concerns in making pro-active recommendations about fraud detection and prevention strategies and in conducting investigations and should be ready to prepare or assist in such assessments for employers or clients just as they currently do in other fraud deterrence related business processes.

Although many hard-numbers-oriented investigators will be wary of becoming involved with the soft risk assessment of management’s tone-at-the-top ethically shaped decisions, they should bear in mind that the world is changing to put a much higher value on the quality and impact of management’s whole governance structure, the posture of which cannot failure to negatively or positively affect the design of the client’s fraud control and prevention programs.

Risk-Centric Fraud Prevention

A number of our certified Chapter members, currently practicing both independently and as corporate staff, report being asked to proactively assist in the establishment of first time internal fraud prevention programs by clients and employers. That this development is something new is borne out by recent articles in the trade press but, on a moment’s reflection, shouldn’t be surprising since CFEs are so uniquely qualified for the particular task.

At a time when an increasingly volatile stock environment, increased cases of cyber fraud, the pressure of globalization and a multitude of increased regulatory requirements are of major concern to all managements, risk assessment and fraud prevention really have to play an important role in ensuring that corporations are not exposed to unexpected and poorly controlled risks. Internal fraud prevention related activities need to be revisited with a focus not just on all these new business paradigms but also on stakeholders’ expectations, transparency, and accountability.

It just makes sense then that today’s environment also calls for greater collaboration and strong relationships between all types of assurance professionals with their clients at all levels to ensure an internal anti-fraud structure is in place (if one doesn’t presently exist) that facilitates a healthy, secure and transparent operating environment.

To facilitate the establishment of a risk-centric approach, today’s fraud prevention functions (new or presently existing) must continually revisit their methodologies, processes, and practices. CFEs can provide experienced insight and real-time value to their client organization by expanding their consulting efforts to facilitate a risk-centric approach, helping to establish the foundation for a more sophisticated and nimble tone at the top, and by focusing on increased collaboration and strategic engagement.

Fraud prevention efforts have been dominated for some time now by a control focused approach that is often reactive and regressive in actual practice in the face of today’s swiftly changing realities. Anti-fraud professionals today need to widen their proactive scope to address the growing governance threats and risk management needs of increasingly global organizations. This requires them to adopt a revised risk-centric approach that involves:

–Taking fraud prevention and business ethics from a compliance perspective to a cultural mind-set. Accurately assessing these risks requires more than just checking to see whether rules are being followed; practitioners must also try to ensure that the spirit of these rules is incorporated into activities at every level.

–Determining key business and fraud risks rather than casting a wide net over numerous risks, many of which may be remote or obscure; the concept of critical business process identification drawn from disaster recovery and continuous operations planning is especially relevant here.

–Identifying emerging risk issues and trends, such as changes in the regulatory environment (which are often wholly reactive), and bringing them to the attention of key stakeholders.

–Estimating the significance of each fraud risk and assessing its probability of occurrence based on a deeper understanding of the present sense conveyed by constantly shifting data and as sometimes pinpointed by sophisticated statistical analysis.

–Identifying programs and controls designed to more sensitively detect and address risk and by concurrent testing of their effectiveness in real-time.

–Coordinating with the other critical risk and control related business processes, such as compliance, risk management, fiscal control, and legal, to ensure that fraud risks are identified, controlled and managed appropriately.

To provide real strategic value to the organization, new and existing fraud prevention practitioners need to help develop risk-based action plans that respond to their present state of risk assessment awareness and which focus on stakeholder expectations. Internal anti-fraud plans should incorporate risk identification and prioritization, as well as analysis and quantification of risk factors particularly in the new business ventures and strategies so characteristic of today’s volatile environment. Such planning should also reflect an understanding of shared risks among various projects and initiatives, and feature continuous monitoring of business activities and key performance indicators.

In the present cyber-threat laden environment the internal fraud prevention business process has to move from being just another routine and disconnected function to being a fulcrum of organizational governance and risk, working in concert with management, the board, and external auditors. Top management can establish the fraud prevention function’s role by:

–Allowing senior fraud examiners and investigators exposure to security information presently associated with key management and governance committees;
–Championing the importance of ethical conduct, fraud identification and fraud prevention consistently.
–Taking immediate and proactive action on fraud examination and investigative findings regardless of whatever level of the organization suspected perpetrators are identified.
–Holding senior executives accountable for identified instances of fraud, waste and abuse in business processes over which they exercise management oversight.
–Supporting the management of the fraud prevention function when its findings and recommendations to improve security prove politically unpopular.
–Defining fraud prevention’s role and management’s expectations.
–Providing appropriate funding, talent and authority to the function.

The ACFE has long indicated that a strong tone at the top from senior management about the importance of a internal fraud prevention function goes a long way toward promoting the engagement of managers throughout the client organization.

For staff assigned to an internal fraud prevention plan to proactively review important business strategies successfully for fraud vulnerability, examiners need to collaborate with management. In addition to providing assurance on compliance initiatives, examiners should develop a forward-looking approach to their assessment planning in which they cooperate and coordinate with related risk and control functions, focus on critical business risks and exposures, and determine the relevance and effectiveness of gathered executive responses to help an organization manage fraud risk proactively. To be forward-looking, fraud prevention professionals need to be fully integrated into the strategic planning process so that they can clearly identify which fraud related risks the organization will be undertaking. They also must be involved with the business in evaluating problems that come to light to determine whether they are the result of control weaknesses that could also emerge in other parts of the organization.

To identify and analyze rapidly emerging risks, direct resources toward areas of greatest risk, and conduct targeted, real-time investigations in response to specific, predicated risks, examiners must leverage technology, learn new skills, and work with management to understand and clarify their evolving expanded role.

To assess the new emerging risks effectively, fraud prevention professionals must develop a deeper understanding of the client business and of the processes that make competitors in the client’s industry successful. An effective fraud prevention activity that can deal with contemporary business risks and meet the ever-increasing demands of management and stakeholders requires a solid staffing strategy. As CFEs we must help spread the word that our client organizations need to invest in skilled resources, methods, training, career paths, and technical infrastructure to deal with increasing cyber-related business risks related to fraud, their internal controls, and government imposed regulations. When staffing a fraud prevention function, top management should:

–Establish a program for selecting and developing the fraud prevention team.
–Identify the skills and expertise required for an effective anti-fraud business process; the ACFE’s guidance and training programs are an invaluable resource to any organization contemplating a new fraud prevention function or looking to strengthen an existing one.
–Assess existing resources to identify staffing gaps.
–Identify and create key performance indicators for deploying fraud prevention and investigatory resources.
–Co-source or outsource internal fraud prevention activities, based on an assessment of current resources, budget, and strategic and tactical requirements.

Acquiring new skills through ACFE training can enable internally focused examiners to direct resources to those techniques that are the most effective in identifying risks to the organization. Especially important is the need to develop deep expertise in specialties such as credit, IT, finance, compliance, and cyber. In addition, investigators and examiners will have to be trained to approach their work strategically, beginning with a detailed understanding of where its owners and stakeholders view where the client business has been and where it is going.

In summary, progressive internal fraud prevention and investigation functions need to partner with their client organization’s risk management function to gain comprehensive visibility into enterprise-wide risks and to support performance of automation supported follow-on risk assessments that can help prevent fraud vulnerability issues from turning into fraud events. Such insight into the organization’s risk profile allows internal investigative professionals to deliver more strategic value by focusing their proactive fraud risk evaluation efforts on areas that represent the greatest risk to the organization as well as proactively anticipating where emerging fraud risk issues are most likely to cause problems. In addition, leveraging the activities performed by the client’s risk management function can lower fraud prevention’s overall cost of operation.

An Ancient Skill

I remember Professor Jerome Taylor in his graduate class at the University of Chicago introducing us to the complexities of what the ancients called the trivium. Because the setting for the process of fraud examination is so often fraught with emotion and confusion, even a beginning fraud examiner quickly realizes that presenting evidence collected during examination fieldwork merely as a succession of facts often isn’t enough to fully convince clients and to adequately address their many concerns (many of which always seem to emerge all at once). To capture stakeholders’ attention, and to elicit a satisfactory response, CFEs need to possess some degree of rhetorical skill.

Rhetoric refers to the use of language to persuade and instruct. Throughout the Middle Ages, European universities taught rhetoric to beginning students as one of three foundational topics composing what was known as the trivium. Logic and grammar, the other two foundational topics, refer to the mechanics of thought and analysis, and to the mechanics of language, respectively. We CFEs and forensic accountants essentially follow the trivium in our work, whether we realize it or not. After gathering evidence through fieldwork, we apply logic to analyze that evidence and to present our vision of the facts to our client organizations in our final reports. We also use grammatical rules to structure text within our reports and memorandum.

Applying the trivium requires a balanced approach; too much focus on any one of the three components to the exclusion of the others can lead to ineffective communication. Fraud examiners need to consider all three trivium components evenly and avoid the common trap of collecting too much evidence or performing too much analysis in the belief that such concentrations will help strengthen our final reports.

The ancient Greeks defined three key components of rhetoric, the speech itself (text), the speaker delivering the speech (author), and those who listen to the speech (audience). Collectively, these components form what’s called the rhetorical triangle. For CFEs, the triangle’s three points equate to the final report or memorandum, the CFE him or herself, and our clients or stakeholders. All three of the rhetorical triangle components are interrelated, and they are each essential to the success of all investigative and/or assurance work. Each should be considered before any engagement and kept in mind throughout the engagement life cycle but especially during the report writing and presentation process.

Although the investigative team lead would be considered the primary author, each of the engagement team members plays a supporting role by authoring observations and preliminary findings that are then compiled into an integrated report. The person performing the important task of draft reviewer also has a role to play, ensuring that the final report meets ACFE and other applicable standards and fulfills the overall purpose defined in the planning document.

The character of the intended audience should be considered with each engagement. Audience members are not homogeneous; each may have different perspectives and expectations. For this reason, CFEs need to consult with them and consider their perspectives even before the engagement begins to the extent feasible.

Once engagement fieldwork has been completed, the authors compose a written report containing the results of the investigative field work. The report represents perhaps the most important outcome communication from the examination process, and the best chance to focus the client’s attention.

When crafting the final report, three separate but interrelated components, designated ‘appeals’, need to be considered and applied: ethos, logos, and pathos.

Ethos is an appeal to the audience’s perception of the honesty, authority, and expertise of the report’s author. Closely related to reputation, ethos is established when the audience determines that the author is qualified, trustworthy, and believable. Because the term ethics derives from ethos, adhering to ACFEs standards and Code of Ethics supports this appeal.

Some helpful formulations, in the form of questions, to keep in mind regarding the ethos component when formulating your report are:

–What assumptions does your audience likely make about you and the investigative process, what you produce, and the level of service you and your team provide?
–Is there a way to take advantage of their positive assumptions to improve the fraud investigation process for the future?
–What can you do to overcome their negative assumptions, if any?
–Do you create the expectation that what you produce and the level of service you provide will be above average or even exceptional?
–Are you using all the available channels to create an impression of excellence?

For CFEs with an on-going or long-term employment or other relationship with the client, the need to consider ethos begins long before the start of any particular engagement. Ethos is supported by the structure and governance of the fraud examination or forensic accounting function as well as by the selection of team members, including alignment between the type of engagements to be performed and the team’s qualifications, education, and training. The ethos appeal is also established by choosing to comply with examination and audit standards and with other professional requirements to demonstrate a high level of credibility, build trust, and gain a favorable reputation over time.

Logos appeals to the audience’s sense of logic, encompassing factors such as the reason and analysis used, the underlying meaning communicated, and the supporting facts and figures presented. The written document’s visual appeal, diagrams, charts, and other elements, as well as how the information is organized, presented, and structured, also factor into logos. Story conveys meaning. From the time we’re born we learn about the world around us through narratives. This aspect of logos continues to be important throughout our lives. We experience the world through our senses, particularly our eyes. Design and visual attractiveness are key to engaging an audience made up of the visual animals we are.

–Is what you are presenting easy to understand?
–Is your presentation design simple and pleasing to the eye?

Investigators need for logos is addressed by their written report’s executive summary; detailed observations, and findings as well as appendices with secondary information that can be used to further instruct the audience. The report describes the origin, drivers and overall purpose of the engagement, its findings, and conclusions. Ultimately, from a rhetorical standpoint, examiners try to tell a convincing, self-contained short story that conveys key messages to the audience. The structure and format of the report, together with its textual content and visual elements, also support the logos appeal.

Like ethos, the logos appeal is fulfilled long before an individual engagement begins. It starts with the rational, periodic assessment and identification of business processes at high-risk for fraud; areas requiring management’s attention, resulting in the development and implementation of effective anti-fraud controls. CFEs are then prepared to undertake engagements, executing steps to collect valid and relevant evidence to justify conclusions and to guide and support the client’s initiation of successful prosecutions.

Pathos is an appeal to the audience’s emotions, either positive (joy, excitement, hopefulness) or negative (anger, sadness). It is used to establish compassion or empathy. Unlike logos, pathos focuses on the audience’s irrational modes of response. The Greeks maintained that pathos was the strongest and most reliable form of persuasion. Pathos can be especially powerful when it is used well and connects with the audience’s underlying values and perspective. Used incorrectly, however, pathos can distort or detract from the impact of actual factual evidence.

Examiners should strive to walk a mile in someone else’s shoes and look for ways to better understand the client/audience’s perspective. Attention to pathos can help support not only examination objectives, but the overarching goal of creating a satisfactory investigative outcome. CFEs should also be mindful of their overall tone and word selection, and ensure they balance negative and positive comments giving credit to individuals and circumstances where credit is due.

To some extent, pathos is interdependent with ethos and logos: The sting of negative results can be reduced somewhat by the positive effect of the other two appeals. For example, clients/audience members are more likely to accept bad news from someone they trust and respect, and who they know has followed a rational, structured approach to the engagement. But at the same time, ethos and logos can be offset by negative pathos. Preferred practice generally consists of holding regular meetings with corporate counsel and/or other critical stakeholders over the course of the investigation, maintaining transparency, and providing stakeholders with an opportunity to address investigative findings or provide evidence that counters or clarifies the CFEs observations.

In summary, while all three elements of rhetorical appeal play an important role in communication and while none should be neglected, CFEs and forensic accountants should pay particular attention to pathos. The dominance of feelings over reason is part of human nature, and examiners should consider this powerful element when planning and executing engagements and reporting the results. By doing so, certified investigators can help ensure audiences accept our message and make informed judgements related to fraud recovery, prosecution and possible restitution.

Loose Ends

A forensic accountant colleague of mine often refers to “loose-ends”. In his telling, loose-ends are elements of an investigation that get over-looked or insufficiently investigated which have the power to come back and bite an examiner with ill effect. That a small anomaly may be a sign of fraud is a fact that is no surprise to any seasoned investigator. Since fraud is typically hidden, the discovery of fraud usually is unlikely, at least at the beginning, to involve a huge revelation.

The typical audit does not presume that those the auditor examiners and the documents s/he reviews have something sinister about them. The overwhelming majority of audits are conducted in companies in which material fraud does not exist. However, the auditor maintains constant awareness that material fraud could be present.

Imagine a policewoman walking down a dark alley into which she knows a suspect has entered just before her. She doesn’t know where the suspect is, but as she walks down that alley, she is acutely aware of and attuned to her surroundings. Her senses are at their highest level. She knows beyond the shadow of a doubt that danger lurks nearby.

Fraud audits (and audits in general) aren’t like that. Fraud audits are more like walking through a busy mall and watching normal people go about their daily activities. In the back of the examiner’s mind, he knows that among all the shoppers are a few, a very few, shoplifters. They look just like everyone else. The examiner knows they are there because statistical studies and past experience have shown that they are, but he doesn’t know exactly where or who they are or when he will encounter them, if at all. If he were engaged to find them, he would have to design procedures to increase the likelihood of discovery without in any way annoying the substantial majority of honest shoppers in whose midst they swim.

A fraud risk assessment evaluates areas of potential fraud to determine whether the current control structure and environment are addressing fraud risk at a level that aligns with the organization’s risk appetite and risk tolerance. Therefore, it is important during the development and implementation of the risk management program to specifically address various fraud schemes to establish the correct levels of control.

It occurred to me a while back that a fraud risk assessment can of thought of as ignoring a loose-end if it fails to include sufficient consideration of the client organization’s ethical dimension. That the ethical dimension is not typically included as a matter of course in the routine fraud risk assessment constitutes, to my mind, a lost opportunity to conduct a fuller, and potentially, a more useful assessment. As part of their assessments, today’s practitioners can potentially use surveys, Control Self-Assessment sessions, focus groups, and workshops with employees to take the organization’s ethical temperature and determine its ethical baseline. Under this expanded model, the most successful fraud risk assessment would include small brainstorming sessions with the operational management of the business process(s) under review. Facilitated by a Certified Fraud Examiner (CFE), these assessments would look at typical fraud schemes encountered in various areas of the organization and identify the internal controls designed to mitigate each of them. At a high level, this analysis examines internal controls and the internal control environment, as well as resources available to prevent, detect, and deter fraud.

Fraud risk assessments emphasize possible collusion and management overrides to circumvent internal controls. Although an internal control might be in place to prevent fraudulent activity, the analysis must consider how this control could be circumvented, manipulated, or avoided. This evaluation can help the CFE understand the actual robustness and resilience of the control and of the control environment and estimate the potential risk to the organization.

One challenge at this point in the process is ensuring that the analysis assesses not just roles, but also those specific individuals who are responsible for the controls. Sometimes employees will feel uncomfortable contemplating a fellow employee or manager perpetrating fraud. This is where an outside fraud expert like the CFE can help facilitate the discussion and ensure that nothing is left off the table. To ask and get the answers to the right questions, the CFE facilitator should help the respondents keep in mind that:

o Fraud entails intentional misconduct designed to avoid detection.
o Risk assessments identify where fraud might occur and who the potential perpetrator(s) might be.
o Persons inside and outside of the organization could perpetrate such schemes.
o Fraud perpetrators typically exploit weaknesses in the system of controls or may override or circumvent controls.
o Fraud perpetrators typically find ways to hide the fraud from detection.

It’s important to evaluate whether the organization’s culture promotes ethical or unethical decision-making. Unfortunately, many organizations have established policies and procedures to comply with various regulations and guidelines without committing to promoting a culture of ethical behavior. Simply having a code of conduct or an ethics policy is not enough. What matters is how employees act when confronted with an ethical choice; this is referred to by the ACFE as measuring the organization’s ethical baseline.

Organizations can determine their ethical baseline by periodically conducting either CFE moderated Control Self-Assessment sessions including employees from high-risk business processes, through an online survey of employees from various areas and levels within the organization, or through workshop-based surveys using a balloting tool that can keep responses anonymous. The broader the survey population, the more insightful the results will be. For optimal results, surveys should be short and direct, with no more than 15 to 20 questions that should only take a few minutes for most employees to answer. An important aspect of conducting this survey is ensuring the anonymity of participants, so that their answers are not influenced by peer pressure or fear of retaliation. The survey can ask respondents to rate questions or statements on a scale, ranging from 1—Strongly Disagree to 5—Strongly Agree. Sample statements might include:

1. Our organizational culture is trust-based.
2. Missing approvals are not a big deal here.
3. Strong personalities dominate most departments.
4. Pressure to perform outweighs ethical behavior.
5. I share my passwords with my co-workers.
6. Retaliation will not be accepted here.
7. The saying “Don’t rock the boat!” fits this organization.
8. I am encouraged to speak up whenever needed.
9. Ethical behavior is a top priority of management.
10.I know where I can go if I need to report a potential issue of misconduct.

The ethical baseline should not be totally measured on a point system, nor should the organization be graded based on the survey results. The results should simply be an indicator of the organization’s ethical environment and a tool to identify potential areas of concern. If repeated over time, the baseline can help identify both positive and negative trends. The results of the ethical baseline survey should be discussed by the CFE with management as part of a broader fraud risk assessment project. This is especially important if there are areas with a lack of consensus among the survey respondents. For example, if the answer to a question is split down the middle between strongly agree and strongly disagree, this should be discussed to identify the root cause of the variance. Most questions should be worded to either show strong ethical behaviors or to raise red flags of potential unethical issues or inability to report such issues promptly to the correct level in the organization.

In summary, the additional value created by combining of the results of the traditional fraud risk assessment with an ethical baseline assessment can help CFEs better determine areas of risk and control that should be considered in building the fraud prevention and response plans. For example, fraud risk schemes that are heavily dependent on controls that can be easily overridden by management may require more frequent assurance from prevention professionals than those schemes that are mitigated by system-based controls. And an organization with a weak ethical baseline may require more frequent assessment of detective control procedures than one with a strong ethical baseline, which might rely on broader entity-level controls. By adding ethical climate evaluation to their standard fraud risk assessment procedures, CFEs can tie up what otherwise might be a major loose-end in their risk evaluation.

The Sword of Damocles

The media provide us with daily examples of the fact that technology is a double-edged sword. The technological advancements that make it easy for people with legitimate purposes to engage with our client businesses and governmental agencies also provide a mechanism for those bent on perpetrating theft and frauds of all kinds.

The access to services and information that customers have historically demanded has opened the flood gates through which disgruntled or unethical employees and criminals enter to commit fraud. Criminals are also exploiting the inadequacies of older fraud management policies or, in some instances, the overall lack thereof. Our parent organization, the Association of Certified Fraud Examiners (ACFE) has estimated that about 70 percent of all companies around the world experienced some type of fraud in 2016, with total global losses due to fraud exceeding US $4 trillion annually and expected to rise continually.  Organizations have incurred, on average, the loss of an estimated 7 percent of their annual revenues to fraud, with $994 billion of that total in the US alone. The ACFE has also noted that the frauds reported lasted a median length of 18 months before being detected. In addition to the direct impact of revenue loss, fraud erodes customer satisfaction and drains investments that could have been directed to corporate innovation and growth. Organizations entrusted with personally identifiable information are also held directly accountable in the eyes of the public for any breach. Surveys have shown that about one-third of fraud victims avoid merchants they blame for their victimization.

We assurance professionals know that criminals become continuously more sophisticated and the fraud they perpetrate increasingly complex. In response, the requirements for fraud risk management have significantly changed over the last few years. Fraud risk management is now not a by-product, but a purposeful choice intended to mitigate or eliminate an organizations’ exposure to the ethically challenged. Fraud risk management is no longer a “once and done” activity, but has become an on-going, ideally concurrent, program. As with all effective processes, it must be performed according to some design. To counter fraud, an organization must first understand its unique situation and the risk to which it may be exposed. This cannot be accomplished in a vacuum or through divination, but through structured analysis of an organization’s current state. Organizations are compelled by their increasingly cyber supported environments to establish an appropriate enterprise fraud risk management framework aligned with the organization’s strategic objectives and supported by a well-planned road map leading the organization to its properly defined target state of protection. Performing adequate analysis of the current state and projecting the organization goals considering that desired state is essential.  Analysis is the bedrock for implementation of any enterprise fraud risk management framework to effectively manage fraud risk.

Fraud risk management is thus both a top-down and a bottom-up process. It’s critical for an organization to establish and implement the right policies, processes, technology and supporting components within the organization and to diligently enforce these policies and processes collaboratively and consistently to fight fraud effectively across the organization. To counter fraud at an enterprise level, organizations should develop an integrated counter fraud program that enables information sharing and collaboration; the goal is to prevent first, detect early, respond effectively, monitor continuously and learn constantly. Counter fraud experience in both the public and for-profit sectors has resulted in the identification of a few critical factors for the successful implementation of enterprise-wide fraud risk management in the present era of advanced technology and big data.

The first is fraud risk management by design. Organizations like the ACFE have increasingly acknowledged the continuously emerging pattern of innovative frauds and the urgency on the part of all organizations to manage fraud risk on a daily, concurrent basis.  As a result, organizations have attempted implementation of the necessary management processes and solutions. However, it is not uncommon that our client organizations find themselves lacking in the critical support components of such a program.  Accordingly, their fraud risk mitigation efforts tend to be poorly coordinated and, sometimes, even reactionary. The fraud risk management capabilities and technology solutions in place are generally implemented in silos and disconnected across the organization.  To coordinate and guide the effort, the ACFE recommends implementation of the following key components:

— A rigorous risk assessment process — An organization must have an effective fraud risk assessment process to systematically identify significant fraud risk and to determine its individual exposure to such risk. The assessment may be integrated with an overall risk assessment or performed as a stand-alone exercise, but it should, at a minimum, include risk identification, risk likelihood, significance assessment and risk response; a component for fraud risk mitigation and implementation of compensating controls across the critical business processes composing the enterprise is also necessary for cost-effective fraud management.

–Effective governance and clearly defined organizational responsibilities — Organizations must commit to an effective governance process providing oversight of the fraud management process. The central fraud risk management program must be equipped with a clear charter and accountability that will provide direction and oversight for counter fraud efforts. The fraud risk must be managed enterprise-wide with transparency and communication integrated across the organization. The formally designated fraud risk program owner must be at a level from which clear management guidelines can be communicated and implemented.

–An integrated counter fraud framework and approach — An organization-wide counter fraud framework that covers the complete landscape of fraud management (from enterprise security, authentication, business process, and application policy and procedure controls, to transaction monitoring and management), should be established. What we should be looking for as CFEs in evaluating a client’s program is a comprehensive counter fraud approach to continually enhance the consistency and efficacy of fraud management processes and practices.

–A coordinated network of counter fraud capabilities — An organization needs a structured, coordinated system of interconnected capabilities (not a point solution) implemented through management planning and proper oversight and governance. The system should ideally leverage the capabilities of big data and consider a broad set of attributes (e.g., identity, relationships, behaviors, patterns, anomalies, visualization) across multiple processes and systems. It should be transparent across users and provide guidance and alerts that enable timely and smart anti-fraud related decisions across the organization.

Secondly, a risk-based approach. No contemporary organization gets to stand still on the path to fraud risk management. Criminals are not going to give organizations a time-out to plug any holes and upgrade their arsenal of analytical tools. Organizations must adopt a risk-based approach to address areas and processes of highest risk exposures immediately, while planning for future fraud prevention enhancements. Countering fraud is an ongoing and continually evolving process, and the journey to the desired target state is a balancing act across the organization.

Thirdly, continual organizational collaboration and systemic learning. Fraud detection and prevention is not merely an information-gathering exercise and technology adoption, but an entire life cycle with continuous feedback and improvement. It requires the organization’s commitment to, and implementation of continual systemic learning, data sharing, and communication. The organization also needs to periodically align the enterprise counter fraud program with its strategic plan.

Fourthly, big data and advanced analytics.  Technological breakthroughs and capabilities grounded in big data and analytics can help prevent and counter fraudulent acts that impact the bottom line and threaten brand value and customer retention. Big data technology can ingest data from any source, regardless of structure, volume or velocity. It can harness, filter and sift through terabytes of data, whether in motion or at rest, to identify and relate the elements of information that really matter to the detection of on-going as well as of potential frauds. Big data off-the-shelf solutions already provide the means to detect instances of fraud, waste, abuse, financial crimes, improper payments, and more. Big data solutions can also reduce complexity across lines of business and allow organizations to manage fraud pervasively throughout the entire life cycle of any business process.

In summary, smart organizations manage the sword of potential fraud threats with well-planned road maps supported by proper organization and governance.  They analyze their state to understand where they are, and implement an integrated framework of standard management processes to provide the guidance and methodology for effective, ethics based, concurrent anti-fraud practice. The management of fraud risk is an integral part of their overall risk culture; a support system of interconnected counter fraud capabilities integrated across systems and processes, enabled by a technology strategy and supporting formal enterprise level oversight and governance.

A Ship of Fools

Our Chapter’s January-February 2018 lecture for CPE credit is concerned with the broader ethical implications of the types of fraud, many interlocking and coordinated, that made up the 2007-2008 Great Recession.  At the center of the scandal were ethically challenged actions by bank managements and their boards, but also by the investment companies and ratings agencies, who not only initiated much of the fraud and deception but, in many cases, actively expanded and perpetuated it.

Little more than a glance at the historical record confirms that deception by bank executives of regulators and of their own investors about illegal activity or about the institution’s true financial condition to conceal poor performance, poor management, or questionable transactions is not new to the world of U.S. finance. In fact, it was a key practice during the meltdown of the financial markets in 2007. In addition, the period saw heated debate about alleged deception by the rating agencies, Standard & Poor’s, Moody’s, and Fitch, of major institutional investors, who depended on the agencies’ valuations of subprime-backed securities in the making of investment decisions. Thus, not only deceptive borrowers and unscrupulous mortgage brokers and appraisers contributed to the meltdown. The maelstrom of lies and deception that drove the entire U.S. financial system in mid to late 2005 accelerated to the point of no return, and the crisis that ensued proved unavoidable.

There were ample instances of bank deception in the years leading up to the Great Depression of the 1930’s. The facts came out with considerable drama and fanfare through the work of the era’s Pecora Commission. However, the breadth and scope of executive deception that came under the legal and regulatory microscope following the financial market collapse of 2007 to 2009 represent some of history’s most brazen cases of concealment of irresponsible lending practices, fraudulent underwriting, shady financial transactions, and intentionally false statements to investors, federal regulators, and investigators.

According to the ACFE and other analysts, the lion’s share of direct blame for the meltdown lies with top executives of the major banks, investment firms, and rating agencies. They charge the commercial bank bosses with perpetuating a boom in reckless mortgage lending and the investment bankers with essentially tricking institutional investors into buying the exotic derivative securities backed by the millions and millions of toxic mortgages sold off by the mortgage lenders. The commercial bank bosses and investment bankers were, according to these observers, aided and abetted by the rating agencies, which lowered their rating standards on high-risk mortgage-backed securities that should never have received investment-grade ratings but did so because the rating agencies were paid by the very investment banks which issued the bonds. The agencies reportedly feared losing business if they gave poor ratings to the securities.

As many CFEs know, fraud is always the principal credit risk of any nonprime mortgage lending operation. It’s impossible in practice to detect fraud without reviewing a sample of the loan files. Paper loan files are bulky, so they are photographed, and the images are stored on computer tapes. Unfortunately, most investors (the large commercial and investment banks that purchased non-prime loans and pooled them to create financial derivatives) didn’t review the loan files before purchasing them and did not even require the original lenders to provide them with the loan tapes requisite for subsequent review and audit.

The rating agencies also never reviewed samples of loan files before giving AAA ratings to nonprime mortgage financial derivatives. The “AAA’ rating is supposed to indicate that there is virtually no credit risk, the risk being thought equivalent to U.S. government bonds, which the finance industry refers to as “risk-free.”  The rating agencies attained their lucrative profits because they gave AAA ratings to nonprime financial derivatives exposed to staggering default risk. A graph of their profits in this era rises like a stairway to the stars. Turning a blind eye to the mortgage fraud epidemic was the only way the rating agencies could hope to attain, and sustain, those profit levels. If they had engaged forensic accountants to review even small samples of nonprime loans, they would have been confronted with only two real choices: (1) rating them as toxic waste, which would have made it impossible to sell the associated nonprime financial derivatives or (2) documenting that they themselves were committing, aiding and abetting, a blatant accounting fraud.

A statement made during the 2008 House of Representatives hearings on the topic of the rating agencies’ role in the crisis represents an apt summary of how the financial and government communities viewed the actions and attitudes of the three rating agencies in the years leading up to the subprime crisis. An S&P employee, testified that “the rating agencies continue to create an even bigger monster, the CDO [collateralized debt obligation] market. Let’s hope we all are wealthy and retired by the time this house of cards falters.”

With respect to bank executives, the examples of proved and alleged deception during the period are so numerous as to almost defy belief. Among the most noteworthy are:

–The SEC investigated Citigroup as to whether it misled investors by failing to disclose critical details about the troubled mortgage assets it was holding as the financial markets began to collapse in 2007. The investigation came only after some of the mortgage-related securities being held by Citigroup were downgraded by an independent rating agency. Shortly thereafter, Citigroup announced quarterly losses of around $10 billion on its subprime-mortgage holdings, an astounding amount that directly contributed to the resignation of then CEO, Charles Prince;

–The SEC conducted similar investigations into Bank of America, now-defunct Lehman Brothers, and Merrill Lynch (now a part of Bank of America);

–The SEC filed civil fraud charges against Angelo Mozilo, cofounder and former CEO of Countrywide Financial Corp. In the highest-profile government legal action against a chief executive related to the financial crisis, the SEC charged Mozilo with insider trading and alleged failure to disclose material information to shareholders, according to people familiar with the matter. Mozilo sold $130 million of Countrywide stock in the first half of 2007 under an executive sales plan, according to government filings.

As the ACFE points out, every financial services company has its own unique internal structure and management policies. Some are more effective than others in reducing the risk of management-level fraud. The best anti-fraud controls are those designed to reduce the risk of a specific type of fraud threatening the organization.  Designing effective anti-fraud controls depends directly on accurate assessment of those risks. How, after all, can management or the board be expected to design and implement effective controls if it is unclear about which frauds are most threatening? That’s why a fraud risk assessment (FRA) is essential to any anti-fraud  Program; an essential exercise designed to determine the specific types of fraud to which your client organization is most vulnerable within the context of its existing anti-fraud controls. This enables management to design, customize, and implement the best controls to minimize fraud risk throughout the organization.  Again, according to the ACFE (joined by the Institute of Internal Auditors, and the American Institute of Certified Public Accountants), an organization’s contracted CFEs backed by its own internal audit team can play a direct role in this all-important effort.

Your client’s internal auditors should consider the organization’s assessment of fraud risk when developing their annual audit plan and review management’s fraud management capabilities periodically. They should interview and communicate regularly with those conducting the organization’s risk assessments, as well as with others in key positions throughout the organization, to help them ensure that all fraud risks have been considered appropriately. When performing proactive fraud risk assessment engagements, CFEs should direct adequate time and attention to evaluating the design and operation of internal controls specifically related to fraud risk management. We should exercise professional skepticism when reviewing activities and be on guard for the tell-tale signs of fraud. Suspected frauds uncovered during an engagement should be treated in accordance with a well-designed response plan consistent with professional and legal standards.

As this month’s lecture recommends, CFEs and forensic accountants can also contribute value by proactively taking a proactive role in support of the organization’s underlying ethical culture.

Vendor Assessment – Backing Corporate Counsel

Pre-emptive fraud risk assessments targeting client vendor security are increasingly receiving CFE attention. This is because in the past several years, sophisticated cyber-adversaries have launched powerful attacks through vendor networks and connections and have siphoned off money, millions of credit card records and customers’ sensitive personal information.

There has, accordingly, been a noticeable jump in those CFE client organizations whose counsel attribute security incidents to current service providers, contractors and to former partners. The evolution of targets and threats outside the enterprise are powerfully influencing the current and near-future of the risk landscape. CFEs who regard these easily predicted changes in a strategic manner can proactively assist their client’s security and risk leadership to identify new fraud prevention opportunities while managing the emerging risk. To make this happen enterprises require adequate oversight insight into vendor involved fraud security risk as part of a comprehensive cyber-risk management policy.

Few managements anticipated only a few years ago that their connectivity with trusted vendors would ever result in massive on-line exploits on sister organizations like retailers and financial organizations, or, still less, that many such attacks would go undetected for months at a time. Few risk management programs of that time would have addressed such a risk, which represents not only a significant impact but whose occurrence is also difficult to predict. Such events were rare and typically beyond the realm of normal anticipation; Black Swan events, if you will. Then, attackers, organized cyber-criminals and some nation-states began capturing news headlines because of high-profile security breaches. The ACFE has long told us that one-third (32 percent) of fraud survey respondents report that insider crimes are costlier or more damaging than incidents perpetrated by outsiders and that employees are not the only source of insider threat; insider threat can also include former employees, service providers, consultants, contractors, suppliers and business partners.

Almost 500 such retailer breaches have been reported this year alone targeting credit card data, personal information, and sensitive financial information. There has, accordingly, been a massive regulatory response.  Regulators are revisiting their guidelines on vendor security and are directing regulated organizations to increase their focus on vendor risk as organizations continue to expand the number and complexities of their vendor relationships. For example, the US Office of the Comptroller of the Currency (0CC) and the Board of Governors of the US Federal Reserve System have released updated guidance on the risk management of third-party relationships. This guidance signals a fundamental shift in how retail financial institutions especially need to assess third-party relationships. In particular, the guidance calls for robust risk assessment and monitoring processes to be employed relative to third-party relationships and specifically those that involve critical activities with the potential to expose an institution to significant risk. CFEs and other assurance professionals can proactively assist the counsels of their client enterprises to elevate their vendor-related security practices to keep pace with ever-evolving fraud threats and security risk associated with their client’s third-party relationships.

Vendor risk oversight from a security point of view demands a program that covers the entire enterprise, outlining the policy and guidelines to manage and mitigate vendor security risk, combined with clearly articulated vendor contracts negotiated by the corporate counsel’s function. Such oversight will not only help organizations improve cybersecurity programs but also potentially advance their regulatory and legal standing in the future. What insights can CFEs, acting proactively, provide corporate counsel?

First, the need for executive oversight. Executive alignment and business context is critical for appropriate implementation throughout the organization. Proper alignment is like a command center, providing the required policies, processes and guidelines for the program. The decision to outsource is a strategic one and not merely a procurement decision. It is, therefore, of the utmost importance that executive committees provide direction for the vendor risk management program. The program can obtain executive guidance from:

–The compliance function to provide regulatory and other compliance requirements that have specific rules regarding vendor risk management to which the vendor organizations must adhere;

–The IT risk and control function to determine the risk and the risk level, depending on the nature of access/data sensitivity shared with the vendor(s). The vendor risk management program should utilize the key risk indicators provided by this function to address risk during vendor assessments;

–The contract governance function and corporate counsel to ensure that vendor contracts adequately address the need for security assessments and define vendors’ obligations to complete these assessments.

Most larger organizations today deal with a considerable amount of third parties and service providers. Missing contact information, responsibility matrices or updated contracts are typical areas of concern about which risk managers might have engaged CFEs initiate fraud risk assessments. This can pose a significant challenge, especially, when there are multiple teams involved to carry out the procurement business process. A vendor and contract database (VCD) ensures that an accurate and complete inventory of vendors is maintained, including other third-party relationships (e.g., joint ventures, utilities, business partners, fourth parties, etc.).

In effectively assessing a vendor risk management program, the CFE can’t conduct the same type of fraud risk assessment for all vendors. Rather, it’s necessary to identify those vendor services deemed to carry the greatest risk and to prioritize them accordingly. The first step is to understand which vendors and services are in the scope from an active fraud risk management perspective. Once this subset of vendors has been identified and prioritized, due diligence assessments are performed for the vendors, depending on the level of client internal versus vendor-owned fraud prevention and detection controls. The results of these assessments help establish the appropriate trust-level rating (TLR) and the future requirements in terms of CFE assisted reassessments and monitoring. This approach focuses resources on the vendor relationships that matter most, limiting unnecessary work for lower-risk relationships. For example, a vendor with a high TLR should be prioritized over a vendor with a low TLR.

Proper control and management of vendor risk requires continuous re-assessment. It’s important to decide the types of on-going assessments to be performed on vendors depending on the level of their TLR and the risk they represent.

Outsourced relationships usually go through iterations and evolve as they mature. As your client organizations strategize to outsource more, they should also validate trust level(s) in anticipation of more information and resources being shared. With technological advancements, a continuously changing business environment and increased regulatory demands, validating the trust level is a continuous exercise. To get the most rational and effective findings, it’s best to use the results of ongoing assessments. In such a reiterative process, it is necessary to continuously monitor and routinely assess vendors based on the trust level they carry. The program should share information about the vendor security posture and risk levels with corporate counsel or other executive sponsor, who can help the organization progress toward the target profile. Clearly communicating the fraud risk from a business perspective can be an additional feature, especially when reports are furnished to inform internal stakeholders, internal audit functions, lines of business and the board of directors, if necessary.

Vendor fraud risk management elevates information security from a technical control business process to an effective management business process. Regular fraud risk security assessments of vendors give organizations the confidence that their business is aware of the security risk involved and is effectively managing it by transferring, mitigating or accepting it. Comprehensive vendor security assessments provide enterprises with insight on whether their systems and data are being deployed consistently with their security policies. Vendor fraud risk management is not a mere project; it is an ongoing program and requires continuous trust to keep the momentum going. Once the foundational framework has been established, our client organizations can look at enhancing maturity through initiatives such as improving guidelines and procedures, rationalizing assessment questionnaires, and more automation. Awareness and communication are key to ensuring that the program is effective and achieves its intended outcome, securing enterprises together with all their business partners and vendors.

New Rules for New Tools

I’ve been struck these last months by several articles in the trade press about CFE’s increasingly applying advanced analytical techniques in support of their work as full-time employees of private and public-sector enterprises.  This is gratifying to learn because CFE’s have been bombarded for some time now about the risks presented by cloud computing, social media, big data analytics, and mobile devices, and told they need to address those risk in their investigative practice.  Now there is mounting evidence of CFEs doing just that by using these new technologies to change the actual practice of fraud investigation and forensic accounting by using these innovative techniques to shape how they understand and monitor fraud risk, plan and manage their work, test transactions against fraud scenarios, and report the results of their assessments and investigations to management; demonstrating what we’ve all known, that CFEs, especially those dually certified as CPAs, CIAs, or CISA’s can bring a unique mix of leveraged skills to any employer’s fraud prevention or detection program.

Some examples …

Social Media — following a fraud involving several of the financial consultants who work in its branches and help customers select accounts and other investments, a large multi-state bank requested that a staff CFE determine ways of identifying disgruntled employees who might be prone to fraud. The effort was important to management not only because of fraud prevention but because when the bank lost an experienced financial consultant for any reason, it also lost the relationships that individual had established with the bank’s customers, affecting revenue adversely. The staff CFE suggested that the bank use social media analytics software to mine employees’ email and posts to its internal social media groups. That enabled the bank to identify accurately (reportedly about 33 percent) the financial consultants who were not currently satisfied with their jobs and were considering leaving. Management was able to talk individually with these employees and address their concerns, with the positive outcome of retaining many of them and rendering them less likely to express their frustration by ethically challenged behavior.  Our CFE’s awareness that many organizations use social media analytics to monitor what their customers say about them, their products, and their services (a technique often referred to as sentiment analysis or text analytics) allowed her to suggest an approach that rendered value. This text analytics effort helped the employer gain the experience to additionally develop routines to identify email and other employee and customer chatter that might be red flags for future fraud or intrusion attempts.

Analytics — A large international bank was concerned about potential money laundering, especially because regulators were not satisfied with the quality of their related internal controls. At a CFE employee’s recommendation, it invested in state-of-the-art business intelligence solutions that run “in-memory”, a new technique that enables analytics and other software to run up to 300,000 times faster, to monitor 100 percent of its transactions, looking for the presence of patterns and fraud scenarios indicating potential problems.

Mobile — In the wake of an identified fraud on which he worked, an employed CFE recommended that a global software company upgrade its enterprise fraud risk management system so senior managers could view real-time strategy and risk dashboards on their mobile devices (tablets and smartphones). The executives can monitor risks to both the corporate and to their personal objectives and strategies and take corrective actions as necessary. In addition, when a risk level rises above a defined target, the managers and the risk officer receive an alert.

Collaboration — The fraud prevention and information security team at a U.S. company wanted to increase the level of employee acceptance and compliance with its fraud prevention – information security policy. The CFE certified Security Officer decided to post a new policy draft to a collaboration area available to every employee and encouraged them to post comments and suggestions for upgrading it. Through this crowd-sourcing technique, the company received multiple comments and ideas, many of which were incorporated into the draft. When the completed policy was published, the company found that its level of acceptance increased significantly, its employees feeling that they had part ownership.

As these examples demonstrate, there is a wonderful opportunity for private and public sector employed CFE’s to join in the use of enterprise applications to enhance both their and their employer’s investigative efficiency and effectiveness.  Since their organizations are already investing heavily in a wide variety of innovative technologies to transform the way in which they deliver products to and communicate with customers, as well as how they operate, manage, and direct the business, there is no reason that CFE’s can’t use these same tools to transform each stage of their examination and fraud prevention work.

A risk-based fraud prevention approach requires staff CFEs to build and maintain the fraud prevention plan, so it addresses the risks that matter to the organization, and then update that plan as risks change. In these turbulent times, dominated by cyber, risks change frequently, and it’s essential that fraud prevention teams understand the changes and ensure their approach for addressing them is updated continuously. This requires monitoring to identify and assess both new risks and changes in previously identified risks.  Some of the recent technologies used by organizations’ financial and operational analysts, marketing and communications professionals, and others to understand both changes within and outside the business can also be used to great advantage by loss prevention staff for risk monitoring. The benefits of leveraging this same software are that the organization has existing experts in place to teach CFE’s how to use it, the IT department already is providing technical support, and the software is currently used against the very data enterprise fraud prevention professionals like staff CFEs want to analyze.  A range of enhanced analytics software such as business intelligence, analytics (including predictive and mobile analytics), visual intelligence, sentiment analysis, and text analytics enable fraud prevention to monitor and assess risk levels. In some cases, the software monitors transactions against predefined rules to identify potential concerns such as heightened fraud risks in any given business process or in a set of business processes (the inventory or financial cycles).  For example, a loss prevention team headed by a staff CFE can monitor credit memos in the first month of each quarter to detect potential revenue accounting fraud. Another use is to identify trends associated with known fraud scenarios, such as changes in profit margins or the level of employee turnover, that might indicate changes in risk levels. For example, the level of emergency changes to enterprise applications can be analyzed to identify a heightened risk of poor testing and implementation protocols associated with a higher vulnerability to cyber penetration.

Finally, innovative staff CFEs have used some interesting techniques to report fraud risk assessments and examination results to management and to boards. Some have adopted a more visually appealing representation in a one-page assessment report; others have moved to the more visual capabilities of PowerPoint from the traditional text presentation of Microsoft Word.  New visualization technology, sometimes called visual analytics when allied with analytics solutions, provides more options for fraud prevention managers seeking to enhance or replace formal reports with pictures, charts, and dashboards.  The executives and boards of their employing organizations are already managing their enterprise with dashboards and trend charts; effective loss prevention communications can make effective use of the same techniques. One CFE used charts and trend lines to illustrate how the time her employing company was taking to process small vendor contracts far exceeded acceptable levels, had contributed to fraud risk and was continuing to increase. The graphic, generated by a combination of a business intelligence analysis and a visual analytics tool to build the chart, was inserted into a standard monthly loss prevention report.

CFE headed loss prevention departments and their allied internal audit and IT departments have a rich selection of technologies that can be used by them individually or in combination to make them all more effective and efficient. It is questionable whether these three functions can remain relevant in an age of cyber, addressing and providing assurance on the risks that matter to the organization, without an ever wider use of modern technology. Technology can enable the an internal CFE to understand the changing business environment and the risks that can affect the organization’s ability to achieve its fraud prevention related objectives.

The world and its risks are evolving and changing all the time, and assurance professionals need to address the issues that matter now. CFEs need to review where the risk is going to be, not where it was when the anti-fraud plan was built. They increasingly need to have the ability to assess cyber fraud risk quickly and to share the results with the board and management in ways that communicate assurance and stimulate necessary change.

Technology must be part of the solution to that need. Technological tools currently utilized by CFEs will continue to improve and will be joined by others over time. For example, solutions for augmented or virtual reality, where a picture or view of the physical world is augmented by data about that picture or view enables loss prevention professionals to point their phones at a warehouse and immediately access operational, personnel, safety, and other useful information; representing that the future is a compound of both challenge and opportunity.

An Ethical Toolbox

As CFE’s we know organizations that have clearly articulated values and a strong culture of ethical behavior tend to control fraud more effectively. They usually have well-established frameworks, principles, rules, standards, and policies that encompass the attributes of generally accepted fraud control. These attributes include leadership, an ethical framework, responsibility structures, a fraud control policy; prevention systems, fraud awareness, third-party management systems, notification systems, detection systems, and investigation systems.

CFE’s are increasingly being called upon to assist in the planning for an assessment of a client organization’s integrity and ethics safeguards and then as active members of the team performing the engagement. The increasing demand for such assessments has grown out of the increasing awareness that a strong ethical culture is a vital part of effective fraud prevention.  Conducting such targeted research within the client organization, within its industry; and its region will help determine the emerging risk areas and potential gaps in most organizational anti-fraud safeguards. Four key elements of integrity and ethics safeguards have emerged over the past few years.  These are the fraud control plan, handling conflicts of interest, shaping ethical dealings with third parties, and natural justice principles for employees facing allegations of wrongdoing.

The need for a fraud control plan is borne out by an organization’s potential fraud losses; typically, about five percent of revenues are lost to fraud each year, according to the ACFE’s 2016 Report to the Nations on Occupational Fraud and Abuse. A fraud control plan typically will articulate an organization’s fraud risks, controls, and mitigation strategies, including:

–Significant business activities;
–Potential areas of fraud risk;
–Related fraud controls;
–Gaps in control coverage and assurance activities;
–Defined remedial actions to minimize fraud risks;
–Review mechanisms evaluating the effectiveness of fraud control strategies.

Management should review and update the fraud control plan periodically and report the results to the audit committee and senior management. Thus, the role of the board and of the audit committee of the board are vital for the implementation of any ethically based fraud control plan. The chairman of the board is, or should be, the chief advocate for the shareholders, and completely independent of management. It is the chairman’s primary job to direct the company’s executives and drive oversight of their activities in the name of the shareholders. An independent and highly skilled audit committee chairman is essential to maintain a robust system of checks and balances over all operations. To be truly effective, the chairman must be independent of those he or she is charged with watching.  The chairmen of the board and the audit committee must devote material time to their duties. While the board can use the company’s oversight functions to maintain a checks and balances process, there is no substitute for personal, direct involvement. The board must be willing to direct inquiries into allegations of misconduct, and have unquestioned confidential spending authority to conduct reviews and investigations as it deems necessary.

One of the most effective compliance tools available to the board is the day-to-day vigilance of the company’s employees. When an individual employee detects wrongdoing, he or she must have an effective and safe method to report observations, such as a third-party ethics hotline that reports to the chairman of the board and audit committee. All employees must be protected from retribution to avoid any possibility of corrupting the process.

A zero-based budgeting process, requiring that the individual elements of the company’s budget be built from the bottom up, reviewed in detail, and justified, can identify unusual spending in numerous corporate and operating units. This provides an in-depth view of spending as opposed to basing the current year’s spending, in aggregate, on last year’s spending, where irregularities may be buried and overlooked.

In organizations with an internal audit division the overall review would typically be performed by Director of Internal Audit (CAE) whom the CFE and other specialists would support. This review should be integrated into the organization’s wider business planning to ensure synergies exist with other business processes, and should link to the organization-wide risk assessment and to other anti-fraud processes.

The ACFE tells us that there is a growing consensus that managing conflicts of interest is critical to curbing corruption. Reports indicate that unmanaged conflicts of interest continue to cost organizations millions of dollars. To minimize these risks, organizations need a clear and well-understood conflict of interest policy, coupled with practical arrangements to implement and monitor policy requirements. Stated simply, a conflict of interest occurs when the independent judgment of a person is swayed, or might be swayed, from making decisions in the best interest of others who are relying on that judgment. An executive or employee is expected to make judgments in the best interest of the company. A director is legally expected to make judgments in the best interest of the company and of its shareholders, and to do so strategically so that no harm and perhaps some benefit will come to other stakeholders and to the public interest. A professional accountant is expected to make judgments that are in the public interest. Decision makers usually have a priority of duties that they are expected to fulfill, and a conflict of interests confuses and distracts the decision maker from that duty, resulting in harm to those legitimate expectations that are not fulfilled. Sometimes the term apparent conflict of interest is used, but it is a misnomer because it refers to a situation where no conflict of interest exists, although because of lack of information someone other than the decision maker would be justified in concluding (however tentatively) that the decision maker does have one

A special or conflicting interest could include any interest, loyalty, concern, emotion, or other feature of a situation tending to make the decision maker’s judgment (in that situation) less reliable than it would normally be, without rendering the decision maker incompetent. Commercial interests and family connections are the most common sources of conflict of interest, but love, prior statements, gratitude, and other subjective tugs on judgment can also constitute interest in this sense.

The perception of competing interests, impaired judgment, or undue influence also can be a conflict of interest. Good practices for managing conflicts of interest involve both prevention and detection, such as:

–Promoting ethical standards through a documented, explicit conflict of interest policy as well as well-stated values and clear conflicts provisions in the code of ethics;
–Identifying, understanding, and managing conflicts of interest through open and transparent communication to ensure that decision-making is efficient, transparent, and fair, and that everyone is aware of what to do if they suspect a conflict;
–Informing third parties of their responsibilities and the consequences of noncompliance through a statement of business ethics and formal contractual requirements;
–Ensuring transparency through well-established arrangements for declaring and registering gifts and other benefits;
–Ensuring that decisions are made independently, with evidence that staff and contractors routinely declare all actual, potential, and perceived conflicts of interests, involving at-risk areas such as procurement, management of contracts, human resources, decision-making, and governmental policy advice;
–Establishing management, internal controls, and independent oversight to detect breaches of policy and to respond appropriately to noncompliance.

Contemporary business models increasingly involve third parties, with external supplier costs now representing one of the most significant lines of expenditure for many organizations. Such interactions can provide an opportunity for fraud and corruption. An enterprise’s strong commitment to ethical values needs to be communicated to suppliers through a Statement of Business Ethics. Many forward-thinking organizations already have codes of ethics in place that set out the values and ethical expectations of both their board members and staff. The board code of conduct should define the behavioral standards for members, while the staff code of conduct should detail standards for employee conduct and the sanctions that apply for wrongdoing. Similar statements also are appropriate for third parties such as suppliers, service providers, and business partners.

A statement of business ethics outlines both acceptable and unacceptable practices in third-party dealings with an organization. Common features include:

–The CEO’s statement on the organization’s commitment to operating ethically;
–The organization’s values and business principles;
–What third parties can expect in their dealings with the organization and the behaviors expected of them;
–Guidance related to bribery, gifts, benefits, hospitality, travel, and accommodation; conflicts of interest; confidentiality and privacy of information; ethical communications; secondary employment; and other expectations.
–Contact information for concerns, clarification, reporting of wrongdoing, and disputes.

Once established, the organization needs to implement a well-rounded communication strategy for the statement of business ethics that includes education of staff members, distribution to third parties, publication on the organization’s website, references to it in the annual report, and inclusion in future tender proposals and bid packs.

Engaged and capable employees underpin the success of most organizations, yet management does not always recognize the bottom-line effects and employee turnover costs when innocent employees are the subject of allegations of fraud and other wrongdoing. About 60 percent of allegations against employees turn out to be unsubstantiated, according to the ACFE. A charter of rights compiles in a single document all the information that respondents to allegations of wrongdoing may require. Such a charter should be written in an easy-to-understand style to meet the needs of its target audience. It should:

–Outline the charter’s purpose, how it will operate, how it supports a robust complaints and allegations system, and how it aligns with the organization’s values;
–Describe how management handles workplace allegations and complaints, and ensure principles of natural justice and other legislative obligations, such as privacy, are in place;
–Provide a high-level overview diagram of the allegation assessment and investigation process, including the channels for submitting allegations; the distinct phases for logging, assessing, and investigating the allegations; and the final decision-making phase;
–Include details of available support such as contact information for human resource specialists, details about an external confidential employee help line, and processes for updates throughout the investigation;
–Illustrate the tiered escalation process for handling allegations that reflects (at one end) how issues of a serious, sensitive, or significant nature are addressed, and encourages (at the other end) the handling of low level localized issues as close to the source as possible;
–Provide answers to frequent questions that respondents might have about the process for dealing with allegations, such as “What can I expect?” “Are outcomes always reviewable?” “What does frivolous and vexatious mean?” “What will I be told about the outcome?” and “What happens when a process is concluded?”;
–Outline the options for independent reviews of adverse investigation outcomes.