Tag Archives: Fraud Prevention

Inflexible Reporting

Our Chapter and the ACFE have published a number of articles and posts over the last few years about the various types of pressures that can push ethically challenged employees over the line between temptation and the perpetration of an actual accounting fraud. One category of such pressure stems directly from the nature of our present system of periodic financial reporting which, it can be argued, not only creates unnecessary volatility in the stock and financial markets but ends up requiring rational investors to demand a premium for securities investments by emphasizing the short term risk that near term, inflexable, quarterly earnings targets will not be met. The pressure to meet these short term targets can only give rise to operational inefficiencies which in turn drive up the inherent inefficiency in the transmission of information from public companies to financial markets based on a model which hasn’t changed much since its original definition during the Great Depression years of the 1930’s.

I’ve seen articles in the Journal of Accountancy and in other authoritative financial publications pointing toward a better way and, with the advent of and widening support for the electronic reporting of financial results to the SCC (the XBRL initiative), we can hope we’re well into the drawn of a new age. That there’s been pushback to this effort is understandable. Those familiar with the technical and professional minefield of the present quarterly reporting process can only feel sympathy with those financial officers who have to go through it, quarter by quarter and year after year. Questions originally abounded about process and mechanics like how is electronically published financial information going to be verified and what real controls are there over its reliability? What happens if there’s an honest mistake?

Think about all this from the point of view of the fraud examiner. If enterprises, listed and non-listed, can make the transition from a periodic to a real-time, electronic based financial reporting system, the resulting efficiencies and the decrease in numerous types of fraud related risk would be truly striking. Real-time financial reporting would free our clients from the tyranny of the present, economically nonsensical, reporting of quarterly results. How much of the incentive to commit financial fraud to meet the numbers does that immediately alleviate? As one financial expert after another has pointed out over the years, there’s just no justification for focusing on a calendar quarter as the unit in which to take stock of financial performance, beyond the fact that that’s what’s presently codified in the law. By contrast, what if financial information were published and available to all users on a real-time basis? The immediate availability of such information, continuously updated, on whatever basis is appropriate for the individual enterprise and its industry, would force companies to adopt a reporting unit that ready makes sense to them and to their principal information users. For some companies that unit might be a week, a month, a quarter, semi-annually or a year. So be it. Let a thousand flowers bloom; the upshot is that what would end up being reported would make sense for the company, its industry and for the information users rather than the one-size fits all, set in stone, prescription of the present law.

An additional advantage, and one with immediate implications for fraud prevention, would be the opportunity for increased efficiency in financial markets as investment dollars could be allocated not according to quarterly results or according to the best guess estimates of financial analysts, but by reliable financial information provided directly by the company all the time; goodbye to many of the present information control vulnerabilities that support insider trading because information is not widely and efficiently disseminated. The point is that by employing digital, cloud-based analytics report building tools properly, users of all kinds could customize a set of up-to-date financial reports (in whatever format) on whatever time period, that suits their fancy.

But many have also pointed out that if there is to be such a shift from periodic to real-time financial reporting, there needs to be a fundamental change in basic attitudes toward financial reporting. Those who report and those who inspect financial information will have to change their focus from methods by which the numbers themselves are checked (audited) to methods (as with XBRL) that focus on the reliability of the system that generates the numbers. That’s where fraud examiners and other financial insurance professionals come in. On-line financial information will be published with such frequency and so rapidly, that there will be no time to “check” individual numbers; the emphasis for assurance professionals will, therefore, need to shift away from checking numbers and balances to analysis of and reporting on the integrity of the system of internal controls over the reporting system itself; understanding of the details of the internal control system over financial reporting will gain a level of prominence it’s never had before.

Fraud examiners need to be aware of these issues when counseling clients about the profound impact that digitally based, on-line reporting of financial information is and will have on their fraud prevention and fraud risk assessment programs. As with all else in life, real time financial reporting will inevitably decrease the risk of some fraud scenarios and increase the risk of others.

Fraud Detection-Fraud Prevention

One of our CFE chapter members left us a contact comment asking whether concurrent fraud auditing might not be a good fraud prevention tool for use by a retailer client of hers that receives hundreds of credit card payments for services each day. The foundational concepts behind concurrent fraud auditing owe much to the idea of continuous assurance auditing (CAA) that internal auditors have applied for years; I personally applied the approach as an essential tool throughout by carrier as a chief audit executive (CAE). Basically, the heart of a system of concurrent fraud auditing (CFA) like that of CAA is the process of embedding control based software monitors in real time, automated financial or payment systems to alert reviewers of transactional anomalies in as close to their occurrence as possible. Today’s networked/cloud based processing environments have made the implementation and support of such real time review approaches operationally feasible in ways that the older, batch processing based environments couldn’t.

Our member’s client uses several on-line, cloud based services to process its customer payments; these services provide our member’s client with a large database full of payment history, tantamount to a data warehouse, all available for use on SQL server, by in-house client IT applications like Oracle and SAP. In such a data rich environment, CFE’s and other assurance professionals can readily test for the presence of transactional patterns characteristic of defined, common payment fraud scenarios such as those associated with identity theft and money laundering. The objective of the CFA program is not necessarily to recover the dollars associated with on-line frauds but to continuously (in as close to real time as possible) adjust the edits in the payment collection and processing system so that certain fraudulent transactions (those associated with known fraud scenarios) stand a greater chance of not even getting processed in the first place. Over time, the CFA process should get better and better at editing out or flagging the anomalies associated with your defined scenarios.

The central concept of any CFA system is that of an independent application monitoring for suspected fraud related activity through, for example (as with our Chapter member), periodic (or even real time) reviews of the cloud based files of an automated payment system. Depending upon the degree of criticality of the results of its observations, activity summaries of unusual items can be generated with any specified frequency and/or highlighted to an exception report folder and communicated to auditors via “red flag” e-mail notices. At the heart of the system lies a set of measurable, operational metrics or tags associated with defined fraud scenarios. The fraud prevention team would establish the metrics it wishes to monitor as well as supporting standards for those metrics. As a simple example, the U.S. has established anti-money-laundering banking rules specifying that all transactions over $10,000 must be reported to regulators. By experience, the $10,000 threshold is a fraud related metric investigators have found to be generic in the identification of many money-laundering fraud scenarios. Anti-fraud metric tags could be built into the cloud based financial system of our Chapter member’s client to monitor in real time all accounts payable and other cash transfer transactions with a rule that any over $10,000 would be flagged and reviewed by a member of the audit staff. This same process could have multiple levels of metrics and standards with exceptions fed up to a first level assurance process that could monitor the outliers and, in some instances, send back a correcting feedback transaction to the financial system itself (an adjusting or corrective edit or transaction flag). The warning notes that our e-mail systems send us that our mailboxes are full are another example of this type of real time flagging and editing.

Yet other types of discrepancies would flow up to a second level fraud monitoring or audit process. This level would produce pre-formatted reports to management or constitute emergency exception notices. Beyond just reports, this level could produce more significant anti-fraud or assurance actions like the referral of a transaction or group of transactions to an enterprise fraud management committee for consideration as documentation of the need for an actual future financial system fraud prevention edit. To continue the e-mail example, this is where the system would initiate a transaction to prevent future mailbox accesses to an offending e-mail user.

There is additionally yet a third level for our system which is to use the CFA to monitor the concurrent fraud auditing process itself. Control procedures can be built to report monitoring results to external auditors, governmental regulators, the audit committee and to corporate council as documented evidence of management’s performance of due diligence in its fight against fraud.

So I would encourage our member CFE to discuss the CFA approach with the management of her client. It isn’t the right tool for everyone since such systems can vary greatly in cost depending upon the existing processing environment and level of IT sophistication of the implementing organization. CFA’s are particularly useful for monitoring purchase and payment cycle applications with an emphasis on controls over customer and vendor related fraud. CFA is an especially useful tool for any financial application where large amounts of cash are either coming in or going out the door (think banking applications) and to control all aspects of the processing of insurance claims.

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.

Ambiguous Transactions

As any experienced fraud examiner will be happy to tell you, unambiguously distinguishing individual instances of fraud, waste and abuse, one from the other, can be challenging; that’s because transactions demonstrating characteristics of one of these issues so often share characteristics of the other(s). A spate of recent articles in the trade press confirm the public impression not only that health care costs are constantly rising but that poorly controlled health care provider reimbursement systems represent significant targets of waste and abuse, both within companies themselves and from external bad actors.

While some organizations review their health benefits programs and health administrator organizations annually, others appear to be doing relatively little in this area. Consequently, CFEs are increasingly being asked as audit team members to participate in fraud risk assessments of hearth benefits administration (HBA) programs for corporations, government entities, and nonprofit organizations. As a consequence, ACFE members are increasingly identifying practices that result in recoverable losses as well as losses that were never recovered because some among our client organizations have never effectively audited their health benefit plans.

A good place to start with this type of fraud risk assessment is for the CFE to evaluate the oversight of HBA reporting activities that could identify unidentified losses for the client organization.

Many organizations contract with third-party administrators (TPAs) to oversee their employee insurance claims process, health care provider network, care utilization review, and employee health plan membership functions. In the arena of claims processing, in today’s environment of rising costs, TPAs can make significant claim payment errors that result in financial losses to the CFE’s client organization if such errors are not promptly identified, recovered, and credited back to the plan. Claim overpayments are common in the industry; and most TPAs themselves have audit processes in place to minimize the losses to their clients. Many control assurance professionals incorrectly assume that the claim audit covers all the exposures, as the primary function of claims administration is to pay claims. This misconception can block a true understanding of the nature of the exposures and lessen the client’s sense of the necessity that systematic fraud and waste detection audits of health care claims transactions are performed, both externally and internally.

The trade press recently reported that an administrator for a U.S. federal government health benefit’s health plan changed its method of administering coordination of benefits (COB) from “pursue and pay” to “pay and pursue.” Under “pursue and pay,” the administrator determines who the primary insurance payer is before making payment. Under “pay and pursue,” the administrator pays the insurance claim and pursues a refund only if it itself is determined to be the secondary payer. In this case, the clients were billed for the payment of full benefits, even though they should have been the secondary payers. The financially strapped administrator recovered the overpayments, deposited them into a bank account, and never credited its clients. Following an audit, one of the client plans received a check for $2.3 million for its share of the refunds that were not returned to it. Is this case of apparent deception an example of fraud? Of waste? Or of abuse?

If COB savings had been routinely monitored by each of the plans, along with each client’s other cost containment activities, they would have noticed that the COB savings had fallen off and were next to nothing under “pay and pursue.” When looking at COB, CFEs and client internal auditors should review the provisions of the contract with the administrator to determine who is responsible for identifying other group coverage (OGC), the methodology for investigating OGC, time limitations for recovering overpayments, and the requirements for the reporting of savings to the client organization by the administrator. In conducting their risk assessments, client management and CFEs also should consider the controls over the organization’s oversight of monitoring COB savings and over the other cost containment activities performed by the administrator.

The COB case considered above was intentional deception, but losses also can be unintentional. To recover overpayments, the TPA can use a refund request letter to request refunds from healthcare providers (hospitals, physicians, etc.), or use the provider offset method, which deducts the overpayment from the provider’s next payment. The ACFE has reported one case in which a provider voluntarily returned an overpayment. The administrator’s policy was to return the refund check to the submitting provider with a form to complete including instructions to send the form and the check back to the administrator to initiate a provider offset on the next payment to the provider. No logs were kept of the checks received and returned to the providers. Following an audit, the client found that, because of a lack of training, personnel of its administrator had deposited the returned checks from providers into an administrative holding account. Subsequent to the investigation and administrative staff training, the client’s refund activity increased from almost nothing to more than $1 million a year. Including the monitoring and analyzing of refund activity as a component of the fraud prevention program will unfailingly provide insight into how well claim overpayments are being controlled.

When assessing for fraud risk regarding refund activity for health insurance overpayments, CFEs should pay attention to the collection methods used by the administrator, overpayment amounts and time limitations for recovery, and the use of external vendors and their shared savings on recoveries. Reporting from the administrator should be required to include an analysis of refund activity, the reasons for the refund(s), breakout between solicited and unsolicited refunds, and the balance of outstanding refunds.

Sometimes it cannot be determined whether an organization’s losses are intentional or unintentional. For example, in one review, several organizations contracted with a marketing firm specializing in a new approach to control health-care costs. The marketing firm hired an administrator to process the claims for its clients. After four months with the firm, an alert accountant at one of the organizations questioned why funding requests coming from the marketing firm were running 20 percent higher each month than they had been with the previous administrator. The organization’s finance division requested a review which revealed that the marketing firm had been billing its clients based on claims processed by the administrator, including claims not paid. The firm insisted it had not been aware that the funding requests resulted in client overbilling and agreed to refund the overbilled amounts to the organization.

Monitoring and approving the funding requests against some measure of expected costs can identify when costs should be investigated. When reviewing funding requests, assurance professionals should pay attention to the internal funding approval process, supporting detail provided by the administrator to support the funding, funding limitation controls to identify possible overfunding for follow-up investigation, bank account setup and account access, and the internal funding reconciliation process.

While losses may occur because of the administrator’s practices, losses (waste) also can go undetected because the organization does not perform adequate oversight of the practices used on its accounts. Preferred provider organization (PPO) discounts are common in managed health care plans. When organizations use PPO networks that are independent of the administrator’s contracted network, the PPO networks receive the claim first to reprice it with the negotiated rate. The PPO network generates a repricing sheet, which is sent with the original claim to the administrator for processing and payment.

In one case, no one explained the repricing sheets to the claim examiners, so they ignored them. The claims system automatically priced and loaded the administrator’s network claims with the negotiated rates into the claims system. However, because the client’s external PPO network fees were not in the claims system, the claims were paid at billed charges. The client lost an estimated $750,000 in discounts over a one-year period and was paying 34 percent of the savings to the PPO networks for savings that it never received. The client did not detect the lost discounts because it never reconciled the discounts reported by the PPO’s quarterly billings for its share of the savings to a discount savings as reported by the administrator.

While examining risks regarding discounts, CFE’s auditors should review the administrator’s or independent PPO network’s contracts regarding PPO pricing and access to pricing variation for in-network provider audits, alternative savings arrangements using external vendors for out-of-network providers, and reporting of PPO discount savings. Within their own organizations, auditors should be instructed to review the internal process of monitoring discount reporting and reconcile PPO shared savings to the administrator reporting the discounts.

There are frequent reports on fraud, abuse, and errors in government health programs issued by the U.S. Department of Health and Human Services’ Office of the Inspector General and by the U.S. Government Accountability Office; all these reports can be of use to CFEs in the conduct of our investigations. Because many of our client organization’s health plans mirror government programs, the fraud risk exposure in organizations is almost everywhere the same. Organizations have incurred tremendous losses by not systematically reviewing benefits administration and through lack of understanding of the dynamics of health plan oversight within their organizations. Developing and promoting a team response within an organization to foster understanding of the exposures in the industry is a practical role for all CFEs. This posture puts fraud examiners (as members of the fraud/abuse prevention and response team) in a position to provide management with assurance that the reporting on the millions spent on employees’ health benefits is accurate and reasonable and that associated costs are justified.

Taken Hostage

by Rumbi Petrozzello
2019 Vice President – Central Virginia ACFE Chapter

On March 22, 2018, I flew into the Atlanta Airport and stopped by the airport’s EMS offices to request an incident report. The gentleman who greeted me at the entrance to the offices was very kind and asked me to wait while he pulled up the details of the report for me. He called over to his coworker, who was sitting in front of a computer, and asked him for help. I heard the coworker clicking on his mouse a few times and then he said that his machine didn’t seem to be working. “It hasn’t been working all morning,” he added. The gentleman then gave me a phone number to call for assistance and apologized for not being more helpful. After I called the number, got voicemail and left a message, I became concerned because I was leaving the country the next day for a week and a half and so hoped that someone would get back to me that day.

Unfortunately, no one had called me back by the time I left. When I returned, I found no voicemail. I called again and left a message. A week after that, the airport EMS Chief returned my call with apologies for the delay – their computers had been down, and he was only now able to start getting back to people. Because I had been out of the country and not really following the news, it was only after a couple of months that I put two and two together. At that point I was working on Eye on Fraud, a publication of the AICPA’s Fraud Task Force. The edition was on Ransomware and as I looked at the information concerning Atlanta, I noticed the dates and realized that the day that I flew into Atlanta and visited the EMS office was the same day that the city of Atlanta was struck by a ransomware attack that crippled the city for over a week and resulted in costs to the city exceeding $2.6 million; a lot more than the $52,000 that was demanded in ransom by the attackers. In late November, two Iranians were indicted for the Atlanta and other attacks. The Atlanta ransomware attack featured many characteristics shared by such attacks, be they on individuals, companies, or governments.

Ransomware attacks have been a problem for decades; the first such documented attack took place in 1989. At that time the malicious code was delivered to victims’ computers via floppy disk and the whole exploit was very easy for victims to reverse. 2006 saw a big uptick in ransomware attacks and, today, ransomware is big business for individual cyber criminals and for organized gangs alike, earning them about a billion dollars in 2016.

Ransomware is a form of malware (malicious software), and works in one of two general ways:

1. Crypto-ransomware encrypts hard drives or files and folders.
2. Locker-ransomware locks users out of their machines, without employing encryption.

As time has gone on, ransomware has become more complex and ransomware attacks more sophisticated. One way in which cyber criminals break into computer systems is via human engineering. This can take the form of an email with a malicious attachment or a link to a compromised website. Cyber criminals also take advantage of known weaknesses in computer operating systems. The WannaCry ransomware, which swept the globe several years ago, took advantage of a flaw in Microsoft Windows. This underscores how essential it is to provide cyber training to employees and to update this training often. Employees must be taught to always be vigilant and on the lookout for such attacks, and to maintain awareness of how such threats are constantly changing and migrating. All it takes is a single employee lapse in judgment and attention for malware to get into a business’s computer system. It’s also essential to keep computers and software up to date with the latest patches. WannaCry was successful in part because Microsoft had discontinued its support of some versions of Windows, including for Windows XP and Windows Server 2003. The amount of money companies thought they were saving by continuing to use old unsupported software was dwarfed by the cost of recovery from malware attacks specifically targeting that software.

When CFEs and forensic accountants dialogue with clients about ransomware attack scenarios, we should remind them that cyber criminals are equal opportunity offenders when it comes to such exploits. Employees should be alert to this whether they are working on an employer’s machine or on a personal one. Ransomware has now made its way into the smartphone space, so employees should be made aware that heightened vigilance should extend even to their smartphones. CFEs should additionally work with clients to fund penetration and phishing tests to determine how effective staff training has been and to highlight areas for improvement.

Both individuals and companies should have a plan on how they will deal with a possible ransomware attack. A well-thought out plan can minimize the effects of an attack and can also mean that the reaction to the attack is measured and not mounted on the basis of uncoordinated panic. For example, when LabCorp was attacked in July 2018, the company contained the spread of the malware in less than an hour. Its, therefore, doubly important that we CFEs and forensic accountants work with IT specialists to formulate an advance plan in case of a ransomware or other malware, attack.

Experts recommend that ransom should not be paid. Clients need to be made to understand that when their systems are taken hostage, they are dealing with criminals and criminals are, more often than not, not to be trusted. When the city of Leeds, Alabama, was attacked, the city paid the cyber criminals $12,000 in ransom. Despite making this payment, the hackers restored only a limited number of files. The city was then faced with the expenditure of additional funds in the attempt to recover or rebuild the remaining files. Sometimes hackers will disappear with ransom and restore nothing. In the face of this, companies and individuals should be encouraged to have back up and restoration plans. To be useful, backups must be made regularly and kept physically separate from the machine or network being protected. The recovery plan should be tested at least annually.

Ransomware exploits are not going away any time soon. Ransomware attacks are a way to get money, not only through the ransom demanded itself but also through access to other sensitive information belonging to employees and clients. Often the hacker will demand a nominal amount in ransom and sell the information stolen by access to the company’s network for a lot more.

We, as CFEs and forensic accountants, can help our client address the ballooning threat in a number of ways:

• by performing a risk assessments of clients’ systems and processes, to identify weaknesses and areas for control improvement.
• by providing staff training on security best practices. This training should be updated at least once a year; in addition to updating staff on changes, this will also serve to remind employees to be vigilant. This training must include everyone in a company, even top management and the board.
• by reminding clients to keep software up to date and to consider upgrades or total changes when an application is no longer supported. Encourage management to have software updates automated on employees’ machines.
• by working with clients to create a backup and recovery system, that features off-site backups. This program should be tested regularly, and backups should be reviewed to ensure their integrity.
• by working with IT and third-party vendors on annual penetration and social engineering testing at client locations. The third-party vendors used should be rotated ever three years.

CSO Online predicts that ransomware attacks will rise to one every 14 seconds by the end of 2019. We CFEs and forensic accountants should work with our clients to innovate effective ways to protect themselves and to mitigate the effects of the future attacks that certainly will occur. The key is to ensure that clients remain educated, vigilant and prepared.

Detect and Prevent

I got a call last week from a long term colleague, one of whose smaller client firms recently discovered a long running key-employee initiated fraud. My friend has been asked to assist her client in developing approaches to strengthen controls to, hopefully, prevent such disasters in the future.

ACFE training has consistently told us over the years, and daily experience repeatedly confirmed, that it is simply not possible or economical to stop all fraud before it happens. The only way for a retail concern to absolutely stop shoplifting might be to close and accept orders only over the Internet. Similarly, the only way for a bank to absolutely stop all loan fraud might be for it to stop lending money.

In general, my friend and I agreed during our conversation, that increasing preventive security can reduce fraud losses, but beyond some point, the cost of additional preventive security will exceed the related savings from reduced fraud losses. This is where detection comes in; it may be economical when prevention is not. One way to prevent a salesclerk from stealing from the register would be for the security department to carefully monitor, review, and approve every one of the clerk’s sales. However, it would likely be much more cost effective instead to implement a simple detective control: an end-of-shift reconciliation between the cash in the register and the transactions logged by the cash register during the clerk’s shift. If refunds are not given at the point of sale, the end-of-shift balance of cash in the register should equal the shift’s sales per the transaction logs minus the balance of cash in the register at the beginning of the shift. Any significant failure of these numbers to reconcile would amount to a red flag. Of course, further investigation could show that the clerk simply made an error and so did not commit fraud.

But the cost effectiveness of detective controls, like preventive controls, imposes limits. First, such controls are not cost free to implement, and improving detective controls may cost more than the results they provide. Second, detective controls produce both false positives and false negatives. A false positive occurs when a detective control signals a possible fraud that upon investigation turns up a reasonable explanation for the indicator. A false negative occurs when a detective control fails to signal a possible fraud when one exists. Reducing false negatives means increasing the fraud detection rate.

Similarly, the cost effectiveness of increasing preventive security has a limit as does the benefit of increasing the fraud detection rate. To increase the detection rate, it’s necessary to increase the frequency at which the detective control signals possible fraud. The result is more expensive investigations, and the cost of such additional investigations can exceed the resulting reduction in fraud losses.

As we all learned in undergraduate auditing, controls are essentially policies and procedures designed to minimize losses due to fraud or to other events such as errors or acts of nature. Corrective controls are merely special control types involved once a loss is known to exist. With respect to fraud, an important corrective control involves the investigation of potential frauds and the investigation and recovery process from discovered frauds.

More generally speaking, fraud investigations themselves serve not only a corrective function but also detective and preventive functions. Such investigations are detective of fraud to the extent that they follow up on fraud signals or red flags in order to confirm or disconfirm the presence of fraud. But once fraud is confirmed to exist, fraud examinations shift toward gathering evidence and become corrective by assisting in recovery from the perpetrator and other sources such as from insurance. Fraud investigations are also corrective in that they can lead to the revelation and repair of heretofore unknown weaknesses.

The end result is that the fraud investigation functions to correct the original loss, and the related discovery of the fraud scenario leads to prevention of similar losses in the future. In summary, the fraud examination has served to detect, correct, and prevent fraud. However, fraud investigations are not normally thought of as detective controls. This so is because fraud investigations tend to be much more costly than standard detective controls and therefore are normally used only when there is already some predication in the form of a fraud indicator triggered by a typical detective control. Therefore, the primary functions of fraud investigations are to address existing frauds and help to prevent future ones.

In some cases, the primary benefit of a fraud investigation might be to prevent future frauds. Even when recovery is impossible or impractical (e.g., because the thief has no assets), unwinding the fraud scheme may still have the benefit of leading to the prevention of the same scheme in the future. Furthermore, a company might benefit from spending a very large sum of money to investigate and prosecute a very small theft in order to deter other individuals from defrauding the company in the same way. Many State governments have statutes specifying that every fraud affecting governmental assets, whether large or small, must be fully investigated because taxpayer funds are involved (the assets affected are public property).

There is never a guarantee that investigating a fraud indicator will lead to the discovery of fraud. Depending on the situation, an investigation might lead to nothing at all (i.e., produce a reasonable explanation for the original red flag) or to the discovery of losses due to simple errors, waste, inefficiencies, or even uncontrollable events like acts of nature. If a lender is considering a loan application, a fraud indicator might indicate nothing, fraud, or an error. On the other hand, in regard to the possible theft of raw materials in a production process, a fraud indicator just might indicate undocumented waste or scrap.

Two important factors to consider concerning the general design of a fraud detection process are not only the costs and benefits of detecting, correcting, and preventing a given fraud scenario but also the costs and benefits of detecting, correcting, and preventing errors, waste, uncontrollable events, and inefficiencies in general. Of course, the particular costs that are relevant will vary from one type of business process to another.

As a general rule, we can say that both preventive controls and detective controls cost less than corrective controls. Corrective controls tend to involve hands-on, resource-intensive investigations, and in many cases, such investigations do not result in recovering the loss. On the other hand, preventive controls can also be quite costly. Banks pay armed guards and incur costs to maintain expensive vaults and alarm systems. Companies surround their headquarters with high fences and armed guards, and use security checkpoints and biometric key card systems inside. On the information technology side, firms use sophisticated firewalls and multi-layer access controls. The costs of all these preventive measures can add up to staggering sums in large companies. Of course, losses that are not prevented or corrected in a timely fashion can lead to the ultimate corrective measure: bankruptcy. In fact, some ACFE estimates show that about one-third of all business failures relate to some form of fraudulent activity.

One positive aspect of the cost of preventive controls is that unlike detective controls, they do not generate fraud indicators that lead to costly investigations. In fact, they tend to do their job in complete silence so that management never even knows when they prevent a fraud. The thick door of a bank vault with a time lock prevents bank employees from entering the building at night to steal its contents. Similarly, passwords, pin numbers, and biometric data silently provide access to authorized individuals and prevent access from others.

The problem with preventive controls is that they are always subject to circumvention by determined and cunning fraudsters. There is no perfect solution to preventing acts of fraud, so detection is necessary as a secondary line of defense, and in some cases, as the primary line of defense. Consider a lending company that accepts online loan applications. It may be difficult or impossible to prevent fraudulent applications, but the company can certainly put a sophisticated (and expensive) system in place to analyze applications and provide indicators that suggest when an application may be fraudulent.

In general, the optimal allocation of resources to prevention versus detection depends on the particular business process under consideration. So, there is no general rule that dictates the optimal allocation of resources between prevention versus detection. But there are some general steps that can assist in making the allocation:

1. Analyze the target business process and identify threats and vulnerabilities.
2. Select reasonable preventive controls according to the business process and customs within the client’s industry.
3. Estimate fraud losses given the assumed preventive controls.
4. Identify and add a basic set of detective controls to the system.
5. For a given set of detective controls, identify the optimal mix of false negatives versus false positives. The optimal mix depends on the costs of investigations versus the costs of losses. Large losses and small investigation costs favor relatively low false negatives and high false positives for red flags.
6. Given the assumed mix of false negative and false positive errors, estimate the incremental cost associated with adding the detective (and related corrective) controls, and estimate the resulting reduction in fraud losses.
7. Compare the reduction in fraud losses with the increase in costs associated with adding the optimal mix of detection and correction controls.
8. If increase in costs is significantly lower than the related reduction in fraud losses, consider adding more detective controls. Otherwise, accept the set of detective controls under consideration.

The Unsanctioned Invoice

Of all the frauds classified as occupational, one of the most pernicious encountered by CFEs is the personal purchase with company funds scam. I say pernicious because not only is this type of fraud a cancer, devouring it’s host organization from within, but also because this basic fraud scenario can take on so many different forms.

Instead of undertaking externally involved schemes to generate cash, many employed fraudsters choose to betray their employers by simply purchasing personal items with their company’s money. Company accounts are used by the vampires to buy items for their side businesses and for their families. The list of benefiting recipients goes on and on. In one case a supervisor started a company for his son and directed work to the son’s company. In addition to this ethically challenged behavior, the supervisor saw to it that his employer purchased all the materials and supplies necessary for running the son’s business. As the fraud matured, the supervisor purchased materials through his employer that were used to add a room to his own house. All in all, the perpetrator bought nearly $50,000 worth of supplies and materials for himself and various others using company money.

One might wonder why a purchases fraud is not classified by the ACFE as a theft of inventory or other assets rather than as a billing scheme. After all, in purchases schemes the fraudster buys something with company money, then takes the purchased item for himself or others. In the case cited above, the supervisor took building materials and supplies. How does this differ from those frauds where employees steal supplies and other materials? On first glance, the schemes appear very similar. In fact, the perpetrator of a purchases fraud is stealing inventory just as s/he would in any other-inventory theft scheme. Nevertheless, the heart of the scheme is not the taking of the inventory but the purchasing of the inventory. In other words, when an employee steals merchandise from a warehouse, s/he is stealing an asset that the company needs, an asset that it has on hand for a particular reason. The harm to the victim company is not only the cost of the asset, but the loss of the asset itself. In a purchasing scheme, on the other hand, the asset which is taken is superfluous. The perpetrator causes the victim company to order and pay for an asset which it does not really need in the course of business, so the only damage to the victim company is the money lost in purchasing the particular item. This is why purchasing schemes are categorized as invoice frauds.

Most of the employees identified by the ACFE as undertaking purchase schemes do so by running unsanctioned invoices through the accounts payable system. The fraudster buys an item and submits the bill to his employer as if it represented a purchase on behalf of the company. The goal is to have the company pay the invoice. Obviously, the invoice which the employee submits to his company is not legitimate. The main hurdle for a fraudster to overcome, therefore, is to avoid scrutiny of the invalid invoice and to obtain authorization for the bill to be paid.

As in the many cases of shell company related schemes we’ve written about on this blog, the person who engages in a purchases scheme is often the very person in the company whose duties include authorizing purchases. Obviously, proper controls should preclude anyone from approving her own purchases. Such poorly separated functions leave little other than her conscience to dissuade an employee from fraud. Nevertheless, CFEs see many examples of small to medium sized companies in which this lapse in controls exists. As the ACFE continues to point out, fraud arises in part because of a perceived opportunity. An employee who sees that no one is reviewing his or her actions is more likely to turn to fraud than one who knows that her company applies due diligence in the attempt to detect all employee theft.

An example of how poor controls can lead to fraud was the case where a manager of a remote location of a large, publicly traded company was authorized to both order supplies and approve vendor invoices for payment. For over a year, the manager routinely added personal items and supplies for his own business to orders made on behalf of his employer. The orders often included a strange mix of items; technical supplies and home furnishings might, for instance, be purchased in the same order. Because the manager was in a position to approve his own purchases, he could get away with such blatantly obvious frauds. In addition to ordering personal items, the perpetrator changed the delivery address for certain supplies so that they would be delivered directly to his home or side business. This scheme cost the victim company approximately $300,000 in unnecessary purchases. In a similar case, an employee with complete control of purchasing and storing supplies for his department bought approximately $100,000 worth of unnecessary supplies using company funds. The employee authorized both the orders and the payments. The excess supplies were taken to the perpetrator’s home where he used them to manufacture a product for his own business. It should be obvious that not only do poor controls pave the way for fraud, a lack of oversight regarding the purchasing function can allow an employee to remove huge amounts from the company’s bottom line.

Not all fraudsters are free to approve their own purchases. Those who cannot must rely on other methods to get their personal bills paid by the company. The chief control document in many voucher systems is the purchase order. When an employee wants to buy goods or services, s/he submits a purchase requisition to a superior. If the purchase requisition is approved, a purchase order is sent to a vendor. A copy of this purchase order, retained in the voucher, tells accounts payable that the transaction has been approved. Later, when an invoice and receiving report corresponding to this purchase order are assembled, accounts payable will issue a check.

So in order to make their purchases appear authentic, some fraudsters generate false purchase orders. In one case, an employee forged the signature of a division controller on purchase orders. Thus the purchase orders appeared to be authentic and the employee was able to buy approximately $3,000 worth of goods at his company’s expense. In another instance, a part time employee at an educational institution obtained unused purchase order numbers and used them to order computer equipment under a fictitious name. The employee then intercepted the equipment as it arrived at the school and loaded the items into his car. Eventually, the employee began using fictitious purchase order numbers instead of real ones. The scheme came to light when the perpetrator inadvertently selected the name of a real vendor. After scrutinizing the documents, the school knew that it had been victimized. In the meantime, the employee had bought nearly $8,000 worth of unnecessary equipment.

Purchase orders can also be altered by employees who seek to obtain merchandise at their employer’s expense. In one instance, several individuals conspired to purchase over $2 million worth of materials for their personal use. The ringleader of the scheme was a low-level supervisor who had access to the computer system which controlled the requisition and receipt of materials. This supervisor entered the system and either initiated orders of materials that exceeded the needs of a particular project or altered existing orders to increase the amount of materials being requisitioned. Because the victim organization had poor controls, it did not compare completed work orders on projects to the amount of materials ordered for those projects. This allowed the inflated orders to go undetected.

Another way for an employee to get a false purchase approved is to misrepresent the nature of the purchase. In many companies, those with the power to authorize purchases are not always attentive to their duties. If a trusted subordinate vouches for an acquisition, for instance, busy supervisors often give rubber stamp approval to purchase requisitions. Additionally, employees sometimes misrepresent the nature of the items they are purchasing in order to pass a cursory review by their superiors.

Instead of running false invoices through accounts payable, some employees make personal purchases on company credit cards or running accounts with vendors. As with invoicing schemes, the key to getting away with a false credit card purchase is avoiding detection. Unlike invoicing schemes, however, prior approval for purchases is not required. An employee with a company credit card can buy an item merely by signing his or her name (or forging someone else’s) at the time of purchase. Later review of the credit card statement, however, may detect the fraudulent purchase.

As with invoicing schemes, those who committed the frauds were often in a position to approve their own purchases;, the same is often true with credit card schemes. A manager in one case, reviewed and approved his own credit card statements. This allowed him to make fraudulent purchases on the company card for approximately two years.

Finally, there is, the fraudster who buys items and then returns them for cash. A good example of such a scheme is that in which an employee made fraudulent gains from a business travel account. The employee’s scheme began by purchasing tickets for herself and her family through her company’s travel budget. Poor separation of duties allowed the fraudster to order the tickets, receive them, prepare claims for payments, and distribute checks. The only review of her activities was made by a busy and rather uninterested supervisor who approved the employee’s claims without requiring support documentation. Eventually, the employee’s scheme evolved. She began to purchase airline tickets and return them for their cash value. An employee of the travel agency assisted in the scheme by encoding the tickets as though the fraudster had paid for them herself. That caused the airlines to pay refunds directly to the fraudster rather than to her employer. In the course of two years, this employee embezzled over $100,000 through her purchases scheme.

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.

Forensic Data Analysis

As a long term advocate of big data based solutions to investigative challenges, I have been interested to see the recent application of such approaches to the ever-growing problem of data beaches. More data is stored electronically than ever before, financial data, marketing data, customer data, vendor listings, sales transactions, email correspondence, and more, and evidence of fraud can be located anywhere within those mountains of data. Unfortunately, fraudulent data often looks like legitimate data when viewed in the raw. Taking a sample and testing it might not uncover fraudulent activity. Fortunately, today’s fraud examiners have the ability to sort through piles of information by using special software and data analysis techniques. These methods can identify future trends within a certain industry, and they can be configured to identify breaks in audit control programs and anomalies in accounting records.

In general, fraud examiners perform two primary functions to explore and analyze large amounts of data: data mining and data analysis. Data mining is the science of searching large volumes of data for patterns. Data analysis refers to any statistical process used to analyze data and draw conclusions from the findings. These terms are often used interchangeably. If properly used, data analysis processes and techniques are powerful resources. They can systematically identify red flags and perform predictive modeling, detecting a fraudulent situation long before many traditional fraud investigation techniques would be able to do so.

Big data are high volume, high velocity, and/or high variety information assets that require new forms of processing to enable enhanced decision making, insight discovery, and process optimization. Simply put, big data is information of extreme size, diversity, and complexity. In addition to thinking of big data as a single set of data, fraud investigators and forensic accountants are conceptualizing about the way data grow when different data sets are connected together that might not normally be connected. Big data represents the continuous expansion of data sets, the size, variety, and speed of generation of which makes it difficult for investigators and client managements to manage and analyze.

Big data can be instrumental to the evidence gathering phase of an investigation. Distilled down to its core, how do fraud examiners gather data in an investigation? They look at documents and financial or operational data, and they interview people. The challenge is that people often gravitate to the areas with which they are most comfortable. Attorneys will look at documents and email messages and then interview individuals. Forensic accounting professionals will look at the accounting and financial data (structured data). Some people are strong interviewers. The key is to consider all three data sources in unison.

Big data helps to make it all work together to bring the complete picture into focus. With the ever-increasing size of data sets, data analytics has never been more important or useful. Big data requires the use of creative and well-planned analytics due to its size and complexity. One of the main advantages of using data analytics in a big data environment is that it allows the investigator to analyze an entire population of data rather than having to choose a sample and risk drawing erroneous conclusions in the event of a sampling error.

To conduct an effective data analysis, a fraud examiner must take a comprehensive approach. Any direction can (and should) be taken when applying analytical tests to available data. The more creative fraudsters get in hiding their breach-related schemes, the more creative the fraud examiner must become in analyzing data to detect these schemes. For this reason, it is essential that fraud investigators consider both structured and unstructured data when planning their engagements.

Data are either structured or unstructured. Structured data is the type of data found in a database, consisting of recognizable and predictable structures. Examples of structured data include sales records, payment or expense details, and financial reports. Unstructured data, by contrast, is data not found in a traditional spreadsheet or database. Examples of unstructured data include vendor invoices, email and user documents, human resources files, social media activity, corporate document repositories, and news feeds. When using data analysis to conduct a fraud examination, the fraud examiner might use structured data, unstructured data, or a combination of the two. For example, conducting an analysis on email correspondence (unstructured data) among employees might turn up suspicious activity in the purchasing department. Upon closer inspection of the inventory records (structured data), the fraud examiner might uncover that an employee has been stealing inventory and covering her tracks in the record.

Recent reports of breach responses detailed in social media and the trade press indicate that those investigators deploying advanced forensic data analysis tools across larger data sets provided better insights into the penetration, which lead to more focused investigations, better root cause analysis and contributed to more effective fraud risk management. Advanced technologies that incorporate data visualization, statistical analysis and text-mining concepts, as compared to spreadsheets or relational database tools, can now be applied to massive data sets from disparate sources enhancing breach response at all organizational levels.

These technologies enable our client companies to ask new compliance questions of their data that they might not have been able to ask previously. Fraud examiners can establish important trends in business conduct or identify suspect transactions among millions of records rather than being forced to rely on smaller samplings that could miss important transactions.

Data breaches bring enhanced regulatory attention. It’s clear that data breaches have raised the bar on regulators’ expectations of the components of an effective compliance and anti-fraud program. Adopting big data/forensic data analysis procedures into the monitoring and testing of compliance can create a cycle of improved adherence to company policies and improved fraud prevention and detection, while providing additional comfort to key stakeholders.

CFEs and forensic accountants are increasingly being called upon to be members of teams implementing or expanding big data/forensic data analysis programs so as to more effectively manage data breaches and a host of other instances of internal and external fraud, waste and abuse. To build a successful big data/forensic data analysis program, your client companies would be well advised to:

— begin by focusing on the low-hanging fruit: the priority of the initial project(s) matters. The first and immediately subsequent projects, the low-hanging investigative fruit, normally incurs the largest cost associated with setting up the analytics infrastructure, so it’s important that the first few investigative projects yield tangible results/recoveries.

— go beyond usual the rule-based, descriptive analytics. One of the key goals of forensic data analysis is to increase the detection rate of internal control noncompliance while reducing the risk of false positives. From a technology perspective, client’s internal audit and other investigative groups need to move beyond rule-based spreadsheets and database applications and embrace both structured and unstructured data sources that include the use of data visualization, text-mining and statistical analysis tools.

— see that successes are communicated. Share information on early successes across divisional and departmental lines to gain broad business process support. Once validated, success stories will generate internal demand for the outputs of the forensic data analysis program. Try to construct a multi-disciplinary team, including information technology, business users (i.e., end-users of the analytics) and functional specialists (i.e., those involved in the design of the analytics and day-to-day operations of the forensic data analysis program). Communicate across multiple departments to keep key stakeholders assigned to the fraud prevention program updated on forensic data analysis progress under a defined governance program. Don’t just seek to report instances of noncompliance; seek to use the data to improve fraud prevention and response. Obtain investment incrementally based on success, and not by attempting to involve the entire client enterprise all at once.

—leadership support will gets the big data/forensic data analysis program funded, but regular interpretation of the results by experienced or trained professionals are what will make the program successful. Keep the analytics simple and intuitive; don’t try to cram too much information into any one report. Invest in new, updated versions of tools to make analytics sustainable. Develop and acquire staff professionals with the required skill sets to sustain and leverage the forensic data analysis effort over the long-term.
Finally, enterprise-wide deployment of forensic data analysis takes time; clients shouldn’t be lead to expect overnight adoption; an analytics integration is a journey, not a destination. Quick-hit projects might take four to six weeks, but the program and integration can take one to two years or more.

Our client companies need to look at a broader set of risks, incorporate more data sources, move away from lightweight, end-user, desktop tools and head toward real-time or near-real time analysis of increased data volumes. Organizations that embrace these potential areas for improvement can deliver more effective and efficient compliance programs that are highly focused on identifying and containing damage associated with hacker and other exploitation of key high fraud-risk business processes.

Regulating the Financial Data Breach

During several years of my early career, I was employed as a Manager of Operations Research by a mid-sized bank holding company. My small staff and I would endlessly discuss issues related to fraud prevention and develop techniques to keep our customer’s checking and savings accounts safe, secure and private. A never ending battle!

It was a simpler time back then technically but since a large proportion of fraud committed against banks and financial institutions today still involves the illegal use of stolen customer or bank data, some of the newest and most important laws and regulations that management assurance professionals, like CFEs, must be aware of in our practice, and with which our client banks must comply, relate to the safeguarding of confidential data both from internal theft and from breaches of the bank’s information security defenses by outside criminals.

As the ACFE tells us, there is no silver bullet for fully protecting any organization from the ever growing threat of information theft. Yet full implementation of the measures specified by required provisions of now in place federal banking regulators can at least lower the risk of a costly breach occurring. This is particularly true since the size of recent data breaches across all industries have forced Federal enforcement agencies to become increasingly active in monitoring compliance with the critical rules governing the safeguarding of customer credit card data, bank account information, Social Security numbers, and other personal identifying information. Among these key rules are the Federal Reserve Board’s Interagency Guidelines Establishing Information Security Standards, which define customer information as any record containing nonpublic personal information about an individual who has obtained a financial product or service from an institution that is to be used primarily for personal, family, or household purposes and who has an ongoing relationship with the institution.

Its important to realize that, under the Interagency Guidelines, customer information refers not only to information pertaining to people who do business with the bank (i.e., consumers); it also encompasses, for example, information about (1) an individual who applies for but does not obtain a loan; (2) an individual who guarantees a loan; (3) an employee; or (4) a prospective employee. A financial institution must also require, by contract, its own service providers who have access to consumer information to develop appropriate measures for the proper disposal of the information.

The FRB’s Guidelines are to a large extent drawn from the information protection provisions of the Gramm Leach Bliley Act (GLBA) of 1999, which repealed the Depression-era Glass-Steagall Act that substantially restricted banking activities. However, GLBA is best known for its formalization of legal standards for the protection of private customer information and for rules and requirements for organizations to safeguard such information. Since its enactment, numerous additional rules and standards have been put into place to fine-tune the measures that banks and other organizations must take to protect consumers from the identity-related crimes to which information theft inevitably leads.

Among GLBA’s most important information security provisions affecting financial institutions is the so-called Financial Privacy Rule. It requires banks to provide consumers with a privacy notice at the time the consumer relationship is established and every year thereafter.

The notice must provide details collected about the consumer, where that information is shared, how that information is used, and how it is protected. Each time the privacy notice is renewed, the consumer must be given the choice to opt out of the organization’s right to share the information with third-party entities. That means that if bank customers do not want their information sold to another company, which will in all likelihood use it for marketing purposes, they must indicate that preference to the financial institution.

CFEs should note , that most pro-privacy advocacy groups strongly object to this and other privacy related elements of GLBA because, in their view, these provisions do not provide substantive protection of consumer privacy. One major advocacy group has stated that GLBA does not protect consumers because it unfairly places the burden on the individual to protect privacy with an opt-out standard. By placing the burden on the customer to protect his or her data, GLBA weakens customer power to control their financial information. The agreement’s opt-out provisions do not require institutions to provide a standard of protection for their customers regardless of whether they opt-out of the agreement. This provision is based on the assumption that financial companies will share information unless expressly told not to do so by their customers and, if customers neglect to respond, it gives institutions the freedom to disclose customer nonpublic personal information.

CFEs need to be aware, however, that for bank clients, regardless of how effective, or not, GLBA may be in protecting customer information, noncompliance with the Act itself is not an option. Because of the current explosion in breaches of bank information security systems, the privacy issue has to some degree been overshadowed by the urgency to physically protect customer data; for that reason, compliance with the Interagency Guidelines concerning information security is more critical than ever. The basic elements partially overlap with the preventive measures against internal bank employee abuse of the bank’s computer systems. However, they go quite a bit further by requiring banks to:

—Design an information security program to control the risks identified through a security risk assessment, commensurate with the sensitivity of the information and the complexity and scope of its activities.
—Evaluate a variety of policies, procedures, and technical controls and adopt those measures that are found to most effectively minimize the identified risks.
—Application and enforcement of access controls on customer information systems, including controls to authenticate and permit access only to authorized individuals and to prevent employees from providing customer information to unauthorized individuals who may seek to obtain this information through fraudulent means.
—Access restrictions at physical locations containing customer information, such as buildings, computer facilities, and records storage facilities to permit access only to authorized individuals.
—Encryption of electronic customer information, including while in transit or in storage on networks or systems to which unauthorized individuals may gain access.
—Procedures designed to ensure that customer information system modifications are consistent with the institution’s information security program.
—Dual control procedures, segregation of duties, and employee background checks for employees with responsibilities for or access to customer information.
—Monitoring systems and procedures to detect actual and attempted attacks on or intrusions into customer information systems.
—Response programs that specify actions to be taken when the institution suspects or detects that unauthorized individuals have gained access to customer information systems, including appropriate reports to regulatory and law enforcement agencies.
—Measures to protect against destruction, loss, or damage of customer information due to potential environmental hazards, such as fire and water damage or technological failures.

The Interagency Guidelines require a financial institution to determine whether to adopt controls to authenticate and permit only authorized individuals access to certain forms of customer information. Under this control, a financial institution also should consider the need for a firewall to safeguard confidential electronic records. If the institution maintains Internet or other external connectivity, its systems may require multiple firewalls with adequate capacity, proper placement, and appropriate configurations.

Similarly, the institution must consider whether its risk assessment warrants encryption of electronic customer information. If it does, the institution must adopt necessary encryption measures that protect information in transit, in storage, or both. The Interagency Guidelines do not impose specific authentication or encryption standards, so it is advisable for CFEs to consult outside experts on the technical details applicable to your client institution’s security requirements especially when conducting after the fact fraud examinations.

The financial institution also must consider the use of an intrusion detection system to alert it to attacks on computer systems that store customer information. In assessing the need for such a system, the institution should evaluate the ability, or lack thereof, of its staff to rapidly and accurately identify an intrusion. It also should assess the damage that could occur between the time an intrusion occurs and the time the intrusion is recognized and action is taken.

The regulatory agencies have also provided our clients with requirements for responding to information breaches. These are contained in a related document entitled Interagency Guidance on Response Programs for Unauthorized Access to Customer Information and Customer Notice (Incident Response Guidance). According to the Incident Response Guidance, a financial institution should develop and implement a response program as part of its information security program. The response program should address unauthorized access to or use of customer information that could result in substantial harm or inconvenience to a customer.

Finally, the Interagency Guidelines require financial institutions to train staff to prepare and implement their information security programs. The institution should consider providing specialized training to ensure that personnel sufficiently protect customer information in accordance with its information security program.

For example, an institution should:

—Train staff to recognize and respond to schemes to commit fraud or identity theft, such as guarding against pretext spam calling.
—Provide staff members responsible for building or maintaining computer systems and local and wide area networks with adequate training, including instruction about computer security.
—Train staff to properly dispose of customer information.