Fraud Detection and Investigation

Page

After reading this chapter, you will be able to:

  • Identify some common ways that fraud is detected within companies.
  • Develop a basic investigative policy and create a general plan for dealing with reports of suspected fraud.
  • Assemble a competent fraud investigation team to examine cases of suspected fraud.
  • Know the options for discipline and legal action once a fraud investigation is concluded.

From the book:

My favorite part of my job, by far, is getting in the trenches and investigating cases of suspected fraud. Following a trail of money and tying together people is fun and rewarding. The problem is that a company has to actually detect fraud before it can be investigated. That’s not always as easy as it seems.

Remember that companies put controls in place to ensure that transactions have proper approval and the numbers are recorded correctly. Some of those controls are effective, others are not. People who commit fraud deliberately try to circumvent that system and exploit any perceived weaknesses. So while a system of controls may be very effective for catching errors, it is not necessarily as effective at catching fraud.

 

Even when there are systems of checks and balances in place and employees are charged with the task of overseeing one another’s work, fraud can occur. When managers and executives override the established policies and procedures, the risk of fraud rises dramatically. The chances that fraud will be detected are also decreased when managers and executives override the system.

Detecting Fraud

According to the Association of Certified Fraud Examiners (ACFE), the most common way internal fraud is detected is through a tip from someone. That tipster could be an employee, an outside vendor, a customer, or an anonymous person. More than 34% of internal frauds are detected with tips, so it’s easy to see how important it is for a company to have a way for people to report suspicious activities.

 

It is disturbing, however, to note that 25% of all employee fraud schemes are detected by accident.2 An accidental detection might include a customer’s complaint about an account balance followed by an investigation into that balance that reveals manipulation of the customer’s account. Maybe an employee who always opens the mail has an unexpected absence, and someone else collects the mail and finds a notice for unpaid payroll taxes. Another possibility is a phone call that’s routed to the wrong person, and the one answering the call inadvertently receives information about a fraud.

 

Further down the list of ways to detect fraud are internal controls, internal audits, and external audits. It’s important to know that audit-related activities aren’t nearly as effective at detecting fraud as many may believe. Audits are still an important part of the process, because they do play a role in preventing some fraud from occurring. Yet they should not be heavily relied on to detect fraud.

Audits Versus Investigations

Traditional independent audits have never been designed to detect, and therefore are not effective at doing so. In contrast, forensic accountants and fraud examiners are trained to investigate for fraud… they are put to the task of looking for evidence of fraud. A good fraud investigator has a “nose for fraud”… an investigative intuition that helps them detect and solve financial crimes.

Investigative Policy Checklist

  • Which red flags cause a company to consider an investigation?
  • Who is in charge?
  • What triggers a high-level examination?
  • When should a company escalate to a full-blown investigation?
  • What results cause a company to monitor employees?
  • What results trigger disciplinary action?

Investigative Team

  • Fraud examiner or forensic accountant
  • Internal and external auditors
  • Legal counsel
  • Management representative
  • Board of directors representative
  • Human resources
  • Corporate security
  • Outside consultants

Disciplinary Options Following the Detection of Internal Fraud:

  • Verbal or written reprimand
  • Punishment such as unpaid suspension or loss of privileges or benefits
  • Implementation of a probationary period, during which the employee will be carefully monitored
  • Denial of a pending or planned promotion
  • Demotion from the current position of authority
  • Dismissal from the company
  • Civil action to recover proceeds of fraud
  • Report of fraud to law enforcement for possible criminal action

Note that any disciplinary action should be fully documented in the employee’s personnel records.