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Presented by: Chris Linscott, CPA, CFE, CIRA Director of Consulting Services Keegan, Linscott & Kenon, PC Fraud – “Don’t be Caught off Guard”

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Presentation on theme: "Presented by: Chris Linscott, CPA, CFE, CIRA Director of Consulting Services Keegan, Linscott & Kenon, PC Fraud – “Don’t be Caught off Guard”"— Presentation transcript:

1 Presented by: Chris Linscott, CPA, CFE, CIRA Director of Consulting Services Keegan, Linscott & Kenon, PC Fraud – “Don’t be Caught off Guard”

2 About KLK Keegan, Linscott & Kenon, P.C. (KLK) is a full service nationally affiliated CPA firm located in Tucson, Arizona established in January KLK provides audit, tax, litigation support, fraud, bankruptcy, general accounting and business consulting services. As one of the largest firms in southern Arizona, and a Tucson affiliate of the McGladrey Alliance, national level services are combined with local ownership. Keegan, Linscott & Kenon, PC

3 Agenda What is fraud? Forensic accounting? How does fraud happen? Who commits fraud? The impact of fraud on business. What are the different forms of fraud? & Case studies Lessons learned from the fraud triangle. Conclusion Keegan, Linscott & Kenon, PC

4 What Is Fraud? “…any intentional or deliberate act to deprive another of property or money by guile, deception, or unfair means…..” Source: ACFE Fraud Examiner Manual Keegan, Linscott & Kenon, PC

5 What Is Forensic Accounting? Forensic accounting is the investigation process that analyzes financial transactions for the purpose of detecting fraud. Keegan, Linscott & Kenon, PC

6 How Does Fraud Occur? Keegan, Linscott & Kenon, PC

7 Four Key Elements of Occupational Fraud Is clandestine Violates the perpetrator’s fiduciary duties to the victim organization Is committed for the purpose of direct or indirect financial benefit to the perpetrator Costs the employing organization assets, revenue or reserves Keegan, Linscott & Kenon, PC

8 Examples of Fraud Misrepresentation of material fact Concealment of material fact Bribery Conflicts of interest Theft of money or property Theft of trade secrets and intellectual property Breach of fiduciary duties Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC

9 Factors Present in All Frauds  Intent  Motive External (e.g., substance abuse, peer pressure, health problems, etc.) Internal (e.g., feeling unfairly treated, job pressures, etc.)  Opportunity Real or perceived weaknesses in controls  Rationalization Depersonalization, entitlement, etc.  Concealment Keegan, Linscott & Kenon, PC

10 The Fraud Triangle Opportunity Circumstances exist – ineffective or absent control, or management ability to override controls – that provide opportunity Incentive/Motive/Pressure Management or other employees have an incentive or are under pressure Rationalize Culture or environment enables management to rationalize committing fraud – attitude or values of those involved, or pressure that enables them to rationalize committing a dishonest act Keegan, Linscott & Kenon, PC

11 The Fraud Triangle as a Three Legged Stool Take Away a Leg….. Keegan, Linscott & Kenon, PC

12 Who Commits Fraud? Keegan, Linscott & Kenon, PC

13 Who Commits Fraud? What is the education level of people who commit the most fraud?  High School  Some College  College Degree  Postgraduate Degree Keegan, Linscott & Kenon, PC

14 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Perpetrator Statistics

15 Who Commits Fraud? People in what staff level commit the most fraud?  Owners/Executives  Managers  Employees Keegan, Linscott & Kenon, PC

16 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Perpetrator Statistics Keegan, Linscott & Kenon, PC

17 The employees who take the most money in a single fraud are?  Owners/Executives  Managers  Employees Who Commits Fraud? Keegan, Linscott & Kenon, PC

18 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Perpetrator Statistics

19 What is the age of perpetrators that commit most fraud?  < 26       >60 Keegan, Linscott & Kenon, PC Who Commits Fraud?

20 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Perpetrator Statistics Keegan, Linscott & Kenon, PC

21 How are most frauds detected?  Internal Audit  External Audit  Tips  Accident Keegan, Linscott & Kenon, PC Who Commits Fraud?

22 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Perpetrator Statistics

23 Source: ACFE 2006 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Results of Fraud

24 Source: ACFE 2006 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Reasons for Declining to Prosecute

25 Source: ACFE 2006 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC How Much is Recovered?

26 The Impact of Fraud on Businesses Keegan, Linscott & Kenon, PC

27 Impact of Fraud on Business It is estimated that __ % of gross revenue is lost to fraud?  2%  3%  5%  7% Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC

28 The median loss in a fraud case is $160,000. Nearly 1/3 of fraud schemes caused a loss of more than $500,000. Almost 1/4 of all reported fraud cases topped the $1 million dollar threshold. *1,822 fraud cases reported total dollar losses Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Impact of Fraud on Business

29 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Keegan, Linscott & Kenon, PC Impact of Fraud on Business

30 5% of a company’s gross revenue is lost to fraud!!! “Sad as it may seem, fraud will always take place wherever there is opportunity. The feeding frenzy of fraud will not abate unless fraud prevention is embraced and instituted at all levels of a company.” -- Martin Beigelman, CFE Director of Financial Integrity for Microsoft Corporation Keegan, Linscott & Kenon, PC Impact of Fraud on Business

31 Forms of Occupational Fraud and Abuse 3 Main Areas of Financial Fraud  Asset Misappropriation  Financial Statements  Bribery & Corruption Keegan, Linscott & Kenon, PC

32 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Forms of Occupational Fraud and Abuse

33 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Forms of Occupational Fraud and Abuse

34 * The sum of percentages in this table exceeds 100% because several cases involved schemes that fell into more than one category. Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Types of Occupational Fraud and Abuse (U.S. only) CategoryDescriptionExamples % of All Cases* Median Loss Asset Misappropriations Any scheme in which the perpetrator steals or misuses an organization's assets. Skimming cash receipts Falsifying expense reports Forging company checks89.8%$100,000 Corruption Any scheme that involves an employee's use of their influence in business transactions in a way that violates their duty to the employer for the purpose of obtaining a benefit for themselves or someone else. Bribery Extortion Conflict of interest21.9%$175,000 Fraudulent Statements Any scheme that involves the intentional misstatement or omission of material information in the organization's financial reports. Recording fictitious revenues Concealing liabilities or expenses artificially inflating reported assets4.3%$1,730,000 Forms of Occupational Fraud and Abuse Keegan, Linscott & Kenon, PC

35 Asset Misappropriation Keegan, Linscott & Kenon, PC

36 Asset Misappropriation Cash Skimming Cash Larceny Fraudulent Disbursements Non-Cash Inventory Fixed Assets

37 Source: ACFE 2010 Report to the Nation on Occupation Fraud and Abuse Asset Misappropriation Schemes

38 Case Study: Asset Misappropriation The Story of Frank Kolk and NCH Case Overview What is NCH? – Unsophisticated accounting systems for growing company – Owner/Operator of +30 franchises, +20 apartment buildings, 5 hotels, real estate development – Internal Controls (Huh?) Who is Frank Kolk (and why do we do background checks)? – Controller at NCH making a salary of $75,000 per year – Using a false name – Prior federal fraud conviction, served time in a federal penitentiary – Not a U.S. citizen Keegan, Linscott & Kenon, PC

39 The Schemes (and what internal controls would have prevented them?) – Payroll scheme (+$208,000) – Embezzlement through false vendors accounts payable (+$77,000) debt payments (+$21,000) – Direct payments to non-NCH vendors (+$96,000) – Loan scheme (+$418,000) (you have to love your relatives!) – Refund scheme and use of single member dummy LLC’s (+$200,000) – Cashiers checks (+$100,000) – Fraudulent conveyances (> $1,000,000) – Ghost employees – Total fraud ($3 – $4 Million) Case Study: Pick a scheme, Any Scheme Keegan, Linscott & Kenon, PC

40 The Conviction – 46 month prison sentence and deportation upon release – Mail fraud – Bank fraud – Money laundering – Income tax evasion (use of dead accountants) The Forfeiture – Nine Golden Corral restaurants – House valued at $855,000 (with 14 car garage) – Cash of $147,000 – Two Porsches – 1969 Ford Shelby Mustang – Five other cars and a trailer Keegan, Linscott & Kenon, PC Case Study: Pick a scheme, Any Scheme

41 Fraudulent Financial Reporting Keegan, Linscott & Kenon, PC

42 Fraudulent Financial Reporting How does it occur? Fictitious / overstated revenues Omission / untimely recording or classification of assets Intentional misstatements or omissions of amounts or disclosures designed to deceive financial statement users Usually committed by upper management with authority to override controls Fraudulent financial reporting is the most costly form of occupational fraud

43 Keegan, Linscott & Kenon, PC Fraudulent Financial Reporting How is it detected? Domination of management by a single person or small group without compensating controls Commitment by management to analysts, creditors and other third parties to aggressive or unrealistic forecasts Ineffective communication and support of a company’s value and ethics Reoccurring negative operating cash flow while reporting earnings and earnings growth

44 Keegan, Linscott & Kenon, PC Fraudulent Financial Reporting How is it detected? Rapid growth/profitability (especially in relation to peers) Significant, unusual or highly complex transactions, especially those close to the period end Significant related third party transactions not in the ordinary course of business Reoccurring attempts by management to justify marginal or inappropriate accounting on basis of materiality Formal or informal restrictions on auditors that limit access to people, information or the ability to communicate effectively with the BOD or Audit Committee

45 Summary of Facts: ABC Hospital’s bankruptcy attorney expressed concerns regarding potential fraudulent acts performed by the CFO that resulted in Chapter 11 filing Income reflected in bankruptcy reports seemed inconsistent with limited cash on hand CFO bonus was based upon hospital earnings Keegan, Linscott & Kenon, PC Case Study: Fraudulent Financial Reporting The Story of ABC Hospital

46 Hypothesis: ABC Hospital’s CFO falsified the Company’s earnings reported to create more profitable operating results Bankruptcy reports were altered to meet minimum performance requirements established by the bankruptcy courts and/or to cover up misappropriated assets Keegan, Linscott & Kenon, PC

47 Case Study: Fraudulent Financial Reporting The Story of ABC Hospital Test the Hypothesis (Evidence Gathering): Monthly net assets reported in bankruptcy reports did not roll forward properly ABC Hospital Manual and Electronic Files – Three separate books were maintained 1.Inpatient, out patient & care center activity maintained in accounting software 2.Physician activity maintained in a separate accounting software 3.Off system financial systems maintained in Excel (**used for bankruptcy and BOD reporting) – “Fantasy Island” Keegan, Linscott & Kenon, PC

48 Case Study: Fraudulent Financial Reporting The Story of ABC Hospital Test the Hypothesis (Evidence Gathering): Internal financial results were inconsistent with financial information submitted to the bankruptcy courts and BOD (e.g. December 2000 financials) – Bankruptcy Report - $1,086,786 loss – BOD - $2,250,007 loss – Internal - $3,339,655 loss (agreed to tax return) Keegan, Linscott & Kenon, PC

49 Case Study: Fraudulent Financial Reporting The Story of ABC Hospital Test the Hypothesis (Evidence Gathering): ABC Hospital Manual and Electronic Files (continued) – Physician activity – Payroll and other expenses were transferred to a separate set of books – No intercompany accounts were reconciled or maintained – Significantly overstated receivable (approximately $900,000 uncollectable) – Excluded from bankruptcy reports Keegan, Linscott & Kenon, PC

50 Case Study: Fraudulent Financial Reporting The Story of ABC Hospital Test the Hypothesis (Evidence Gathering): ABC Hospital Manual and Electronic Files (continued) – Net assets decreased $3 mill. Over the CFO’s term – Interviews conducted: Acting CEO Acting CFO Formal external auditors – Bankruptcy reports were signed by CFO stating they were complete and accurate Keegan, Linscott & Kenon, PC

51 Case Study: Fraudulent Financial Reporting The Story of ABC Hospital Conclusion: Based upon the analysis performed, it is our opinion that the CFO engaged in a deliberate system of financial statement fraud for the years 1999, 2000 and 2001 when results of operations were poor. The financial statements submitted to the Board of Directors and bankruptcy courts during those periods were fraudulently prepared and inaccurate, primarily due to the omission of expenses and overstatement of accounts receivable. The CFO had multiple sets of financial records that were used to overstate the financial condition and performance of ABC Hospital. The CFO also suppressed financial information from the outside auditors that would have had great bearing on the financial operations and internal controls of the hospital, which had a direct bearing on his employment. Keegan, Linscott & Kenon, PC

52 Bribery & Corruption Keegan, Linscott & Kenon, PC

53 Off book An illegal/unethical business transaction Not as common as asset misappropriation, but more costly An offering of bribery can constitute bribery —Even if payment is never made Bribery & Corruption

54 Classifications – Bribery (kickbacks & bid-rigging) – Economic Extortion – Illegal Gratuities – Conflicts of Interest Bribery & Corruption Keegan, Linscott & Kenon, PC

55 Corruption occurs when an employee uses their influence in a business transaction in an inappropriate manner to benefit themselves at the expense of the organization. Bribery & Corruption Keegan, Linscott & Kenon, PC

56 Bribery & Corruption Keegan, Linscott & Kenon, PC “Most Commons” – Most Common Schemes – Conflict of Interest and Bribery – Most Common Detection Method – TIPS – Most Common Perpetrator – Managers/Owners/Executives – Most Common Scheme in Not for Profit Organizations

57 Case Study: Corruption FPO Development Players US Government Government Agency – (GA) Not for Profit Organization – (NPO) – Established to provide low income housing For Profit Construction/Development Company – (FPO) – Contracts with NPO to develop and construct low income housing Keegan, Linscott & Kenon, PC

58 US Gov US Gov provides Block Grant Funds to GA for a housing development Gov Agency (GA) GA awards NPO 69m over a 5 yr period to develop housing NPO NPO contracts with FPO to develop housing. NPO pays FPO all grant funds (69m) FPO Keegan, Linscott & Kenon, PC Case Study: FPO Development

59 Contract No other bids considered FPO contract with NPO – 2 pages – Exclusive agreement – Entitles FPO to receive all grant proceeds – Entitles FPO to keep all debt secured against the FPO’s property Keegan, Linscott & Kenon, PC Case Study: FPO Development

60 AIA Contracts – Industry Standard AIA Items NOT addressed in the contract – Specifications – Scope – Applications for payment – Certifications for payment – Change orders – Contract administration – Construction schedule – Award for subcontracts Keegan, Linscott & Kenon, PC Case Study: FPO Development

61 Results FPO – Does not complete jobs – Construction not to regulatory spec’s – Leverages the property with 17m in debt – Official and commercial bribery NPO – Can’t cash flow projects – Files for bankruptcy protection Keegan, Linscott & Kenon, PC Case Study: FPO Development

62 Keegan, Linscott & Kenon, PC Case Study: FPO Development Payments to NPO Board President

63 Keegan, Linscott & Kenon, PC Case Study: FPO Development Payments to Casinos

64 Keegan, Linscott & Kenon, PC Case Study: FPO Development Payments to Casinos

65 Keegan, Linscott & Kenon, PC Case Study: FPO Development Payments to FPO Owner

66 Red Flags Change in lifestyle of NPO Board Members – FPO paid 90k to NPO BOD President Favoring a vendor – FPO was the only vendor considered Paying a vendor higher prices Sole-sourcing – FPO awarded all contracts Keegan, Linscott & Kenon, PC Case Study: FPO Development

67 Red Flags Poor quality – FPO construction of utility does not meet regulations Socializing outside of the professional relationship – Owner of FPO meets NPO and GA officials at Casino’s and provides them with the cash for gambling – FPO claims the amount were loans and were paid back (no support for this claim) Audit Findings – Not resolved Keegan, Linscott & Kenon, PC Case Study: FPO Development

68 Lessons Learned from the Fraud Triangle Keegan, Linscott & Kenon, PC Opportunity Incentive/Motive/Pressure Rationalize

69 Keegan, Linscott & Kenon, PC Opportunity Incentive/Motive/Pressure Management or other employees have an incentive or are under pressure Rationalize Incentive/Motive/Pressure Internal – Bonus systems, employee reviews, job pressures External – More difficult, but knowledge is important

70 Keegan, Linscott & Kenon, PC Opportunity Incentive/Motive/Pressure Rationalize Culture – Fraud policy Tone at the top Rationalize Culture or environment enables management to rationalize committing fraud – attitude or values of those involved, or pressure that enables them to rationalize committing a dishonest act

71 Keegan, Linscott & Kenon, PC Incentive/Motive/Pressure Opportunity Internal Controls – Segregation of duties Review and supervision Asset safeguards No “off-line” systems Background checks Rationalize Opportunity Circumstances exist – ineffective or absent control, or management ability to override controls – that provide opportunity

72 Thank you for your time! Any Questions? Keegan, Linscott & Kenon, PC McGladrey Alliance is a premier affiliation of independent accounting and consulting firms. McGladrey Alliance member firms maintain their name, autonomy and independence and are responsible for their own client fee arrangements, delivery of services and maintenance of client relationships.


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