Welcome! Why The Fraud Triangle Is No Longer Enough [PDF]

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Welcome!



Why the Fraud Triangle is No Longer Enough “Trust is a Professional Hazard!” – Jonathan Marks



Disclaimer & Copyright py g Notice The views expressed herein may not necessarily reflect those of Crowe Horwath LLP. Thus, Crowe Horwath LLP is not, by means of this presentation, rendering business business, accounting accounting, legal advice advice, or other professional advice or services. This presentation is not a substitute for such professional advice or services services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professionals. Crowe Horwath LLP, its affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. All materials including but not limited to graphics graphics, photographs photographs, and text appearing in this presentation are protected by copyright. Reproduction or redistribution in any form is strictly prohibited. prohibited “Trust is a Professional Hazard!” – Jonathan Marks



Overview of Today • • • • • • • •



Corporate Governance and Ethics The Fraud Environment Putting the Freud in Fraud Behavior and the Environment A New N W Way off Thinking Thi ki about b tF Fraud d The Impact of Fraud Organizational Signals and Individual Red Flags Closing Thoughts



“Trust is a Professional Hazard!” – Jonathan Marks



F Fraud, d the th Underestimated U d ti t d Risk Ri k • • • •



CFO records $10 million of erroneous revenues Controller knowingly fails to record inventory obsolescence Sales VP bribes an agent to win business (FCPA violation) Payroll ay o manager a age creates c eates p phantom a to e employees p oyees a and de embezzles be es over $900,000



“Trust is a Professional Hazard!” – Jonathan Marks



Wheel of Misfortune



“Trust is a Professional Hazard!” – Jonathan Marks



Corporate p Governance Framework™



“Trust is a Professional Hazard!” – Jonathan Marks



Corporate p Governance Framework™



Board of Directors & Committees



Legal & Regulatory



Monitoring



Communication & Trust



Business Practices & Ethics



Enterprise Risk Management



Disclosure & Transparency



“Trust is a Professional Hazard!” – Jonathan Marks



Similarities Organized Crime



Typical Multinational Corporation



Big Boss



Chairman



Captain or Lieutenant



Senior Management CEO and CFO



Soldiers



Middle Management and Staff



Associates



Third Parties



Looking g at Ethics



10 80



Unethical



Situational Ethics



10



“Trust is a Professional Hazard!” – Jonathan Marks



Ethical



Integrity “Always Always doing the right thing when no one else is watching.”



“Trust is a Professional Hazard!” – Jonathan Marks



Tiger g Woods



“The issue here is that I cheated, I am the only person to blame. I stopped living according to my core values. I knew what I was doing was wrong but thought only about myself and thought I could get away with whatever I wanted to. I felt I was entitled. I had worked hard. Money and fame made d me believe b li I was entitled. titl d I was wrong and d foolish. I don’t get to live by different rules. The same boundaries that apply to everyone apply to me ” me.



“Trust is a Professional Hazard!” – Jonathan Marks



Classic Ethical Conflicts Truth vs vs. loyalty Justice vs. mercy One vs vs. many Short-term vs. long-term



“Trust is a Professional Hazard!” – Jonathan Marks



The Big g Three



“Trust is a Professional Hazard!” – Jonathan Marks



Quadraphobia



$.544 $



Companies that adjust most often are more likely t restate to t t earnings i or be b charged h d with ith accounting violations.



$ 544 $.544 “Trust is a Professional Hazard!” – Jonathan Marks



Continuously Ask Yourself, Yourself “Wait Wait a Minute, Minute Is This Really Something We Should Be Doing? What Is the Risk? Risk?”



“Trust is a Professional Hazard!” – Jonathan Marks



The Fraud Environment



The Fraud Environment



“Trust is a Professional Hazard!” – Jonathan Marks



Historical Auditors’ Mentality



FRAUD



“Trust is a Professional Hazard!” – Jonathan Marks



The Fraud Environment



Why do we tend to ignore the behavioral and environmental elements?



“Trust is a Professional Hazard!” – Jonathan Marks



Profiling g Overview



Thank you to my friend Dan Korem Korem,, author of The Art of Profiling. “Trust is a Professional Hazard!” – Jonathan Marks



Profiling g Control/Express



Confident/Fearful Co de t/ ea u



Predictable/ ed ctab e/ Unpredictable



Ask/Tell



“Trust is a Professional Hazard!” – Jonathan Marks



Profiling: Evaluating the Finest, Thinnest Wire* Comprehensive Co p e e s e Profile o e



Type



Type



Element or Trait



Element or Trait



Element or Trait



Actions “Trust is a Professional Hazard!” – Jonathan Marks



Elementt El or Trait



Profile – WALK ( (PERFORMANCE TYPE)) INNOVATOR



Tiger g Woods TALK (COMMUNICATION TYPE) SALESMAN



Predictable – Unpredictable: p Confident – Fearful



Control Co t o – Express: p ess Ask – Tell



• Takes risks • Creative • Likes/seeks challenges • Innovative I ti



• Passionate • Outgoing • Friendly



“Trust is a Professional Hazard!” – Jonathan Marks



Profile



INNOVATOR/MANAGER



SALESMAN



Predictable – Unpredictable C fid t – Fearful Confident F f l



Control – Express A k – Tell Ask T ll



• Risk taker • Dependable • Creative • Problem Solver • Assumes Responsibility



• Passionate • Outgoing • Friendly



• “Trust is a Professional Hazard!” – Jonathan Marks



Profile – White-Collar Ci i l Criminal RANDOM ACTOR



SALESMAN



Predictable – Unpredictable Confident – Fearful



Control C t l – Express E Ask – Tell



• Hot Hot-tempered tempered • Egocentric • Deceptive • Secretive • Moody • Without a conscience • Anxious



• Passionate • Outgoing • Friendly



• “Trust is a Professional Hazard!” – Jonathan Marks



Evolution of the Fraud Triangle



“Trust is a Professional Hazard!” – Jonathan Marks



Let’s Compare...



“Trust is a Professional Hazard!” – Jonathan Marks



Perpetrators of Fraud



Most Common Red Flag: Living Beyond Means Source: 2010 ACFE Report to the Nation



“Trust is a Professional Hazard!” – Jonathan Marks



COSO Research Study Fraudulent Financial Reporting: 1998–2007, An Analysis of U U.S. S Public Companies



Thank you, Mark Beasley, North Carolina State University!



“Trust is a Professional Hazard!” – Jonathan Marks



Key Findings Alleged Perpetrators • Orchestrated from the senior executive suite • In 89 percent of cases, a CEO and/or CFO is named. • Motivations include meeting expectations, concealing a deteriorating financial condition, or preparing for debt/equity offering.



“Trust is a Professional Hazard!” – Jonathan Marks



A New Way of Thinking



“Trust is a Professional Hazard!” – Jonathan Marks



Fraud Pentagon Middle-Management Focused d



“Trust is a Professional Hazard!” – Jonathan Marks



CEO, CFO, Larger Fraud Schemes



Five Elements of the Fraud Pentagon™  Arrogance  Competence  Opportunity  Pressure  Rationalization



“Trust is a Professional Hazard!” – Jonathan Marks



Greed and Pressure



Arrogance or greed and pressure account for over 70 percent of the fraudsters’ profiles



Fraud Pentagon was developed and created by Jonathan Marks, CPA/CFF, CFE, CITP, and may not be reproduced in any form.



“Trust is a Professional Hazard!” – Jonathan Marks



Behavioral Red Flags Financial difficulties



35.7%



Living beyond means



34.4%



Di Divorce/family /f il problems bl



20 6% 20.6%



Unusually close assoc with vendor/customer



17.2%



Control issues, unwillingness to share duties



15.1%



"Wheeler-dealer" attitude



15.1%



I it bilit suspiciousness, Irritability, i i or d defensiveness f i



10 7% 10.7%



Addiction problems



10.0%



Past employment-related problems



8.6%



Complained about inadequate pay



6.9%



I t bilit iin lif Instability life circumstances i t



6 % 6.5%



Refusal to take vacations



5.5%



Past legal problems



5.5%



Excessive pressure from within organization



4.5%



Complained about lack of authority



4.1%



Excessive family/peer pressure for success



2.7% 0%



5%



10%



15%



20%



25%



Percent of Cases



“Trust is a Professional Hazard!” – Jonathan Marks



30%



35%



40%



Greed Is Good



“Trust is a Professional Hazard!” – Jonathan Marks



Elements of Fraud: Arrogance •



Big egos – CEO as celebrity” – hubris factor



•



Think they think they can circumvent internal controls and not get caught



•



Bullying attitude



•



Autocratic management style



•



Fear they will lose their position, status, etc.



“. . . Remember that many crimes are committed without economic gain for reasons of ego, status, and sheer arrogance.” Source: Sam E. Antar, convicted felon, ex-CFO, Crazy Eddie



“Trust is a Professional Hazard!” – Jonathan Marks



Over the Top CEO Hubris Over-the-Top It’s like an iceberg. It looks small and unintimidating g from afar. When you collide with it, you realize it’s massive, chilling and a destroyer of chilling, careers and companies.



“Trust is a Professional Hazard!” – Jonathan Marks



Failed Lehman Brothers CEO Richard Fuld was nicknamed “The Gorilla” for his intimidating presence. • Few were willing to second-guess his decisions. • The board was too late to challenge him.



“Trust is a Professional Hazard!” – Jonathan Marks



Elements of Fraud: Competence



•



Competence gives the perpetrator the opportunity to turn desire into reality.



•



Six common traits of personal competence: 1. Functional authority within the organization 2 Sufficient intelligence to understand and 2. exploit a situation 3. Confidence 4. Strong coercive skills 5. Effective deceptiveness 6. High tolerance for stress



“Trust is a Professional Hazard!” – Jonathan Marks



The Business Case: The Impact of Fraud



“Trust is a Professional Hazard!” – Jonathan Marks



Initial Detection of Occupational Fraud



So rce 2010 ACFE Report to the Nation Source:



“Trust is a Professional Hazard!” – Jonathan Marks



Effectiveness of Most Common Anti-Fraud Measures Control Surprise audits Job rotation/mandatory vacation Hotline Employee p y support pp programs p g Fraud training for managers/execs Internal audit/FE Department Fraud training for employees Anti fraud policy Anti-fraud External audit of ICOFR Code of Conduct Mgmt review of IC External audit off F/S /S Independent audit committee Mgmt cert of F/S Rewards for whistleblowers



Median Loss Yes $70,000 $64,000 $100,000 $110,000 $ , $100,000 $118,000 $100,000 $100 000 $100,000 $121,000 $126,000 $110,000 $ $150,000 $137,000 $141,000 $107,000



“Trust is a Professional Hazard!” – Jonathan Marks



No $207,000 $164,000 $250,000 $250,000 $ , $227,000 $250,000 $208,000 $197 000 $197,000 $232,000 $232,000 $200,000 $ $250,000 $200,000 $200,000 $150,000



% reduction 66.2% 61.0% 60.0% 56.0% 55.9% 52.8% 51.9% 49 2% 49.2% 47.8% 45.7% 45.0% 40.0% % 31.5% 29.5% 28.7%



Frequency of Anti-Fraud Measures



“Trust is a Professional Hazard!” – Jonathan Marks



44



Common Financial Statement Fraud Techniques Methods Used to Misstate Financial Statements



Percentage of the 347 Fraud Companies Using Fraud Method



Improper revenue recognition



61%



Overstatement of assets



51%



U d t t Understatement t off expenses/liabilities /li biliti



31%



Misappropriation of assets



14%



Inappropriate disclosure



1%



Other miscellaneous techniques



20%



Disguised g through g the use of related p party y transactions



18%



Insider trading also cited



24%



The Cost of Fraud



“More money has been stolen at the point of a pen than at the point of a gun.” g



“Trust is a Professional Hazard!” – Jonathan Marks



The True Costs of Fraud The true costs of fraud to an organization go beyond dollar losses. These include: Public Public scrutiny Reputation loss Government investigations Loss L off market k t capital it l Severe financial penalties Loss of investor confidence



“Trust is a Professional Hazard!” – Jonathan Marks



Organizational Signals and Individual Red Flags



“Trust is a Professional Hazard!” – Jonathan Marks



Organizational Signals of Fraud: Checklist Category



High Fraud Potential



Lower Fraud Potential



1. Management style



Autocratic



Participative



2.



Power- driven



Achievement-driven



3. Distribution of authority



Centralized, reserved by top



Decentralized, dispersed to all levels, d l delegated t d



4. Planning



Centralized, short range



Decentralized, long range



5. Performance



Measured quantitatively and on a short-term basis



Measured both quantitatively and subjectively



6. Business focus



Profit-focused



Customer-focused



7. Management strategy



Management by crisis



Management by objectives



8. Reporting



Reporting by exception



Reporting by routine



9. Policies and rules



Rigid and inflexible, strongly policed



Reasonable, fairly enforced



10. Customer satisfaction



Many complaints



Few complaints



11. Event anticipation



Crisis management



Tactical planning



12. Independent audit



Audit reports to line management



Audit reports to the CEO and the board



13. Financial planning



Fantasy goals, no budget



Realistic budget and goals



14. Financial reporting



Overly complex financial statements



Transparent reporting



15 Organizational complexity 15.



Numerous material related party transactions Numerous,



Clear delineation of ownership/ affiliations



16. Separation of duties between the accounting functions



No risk analysis



Risk analysis that drives separation of incompatible functions



17. Explicit and uniform personnel policies



Acceptable conduct not defined



Acceptable conduct defined



18. Placing too much trust in key employees



Lack of controls and monitoring



Trust bounded by controls and monitoring



19. Pay levels



Below market compensation



Market compensation



20. Failure to discipline violators of company policy



Inconsistent, double standard



Consistency and certainty



Management orientation



“Trust is a Professional Hazard!” – Jonathan Marks



“If You Don't Don t Know Where You Are Going Going, You Might Wind Up Someplace Else.” – Yogi Berra



“Trust is a Professional Hazard!” – Jonathan Marks



Be Curious



“Trust is a Professional Hazard!” – Jonathan Marks



Have Courage



“Trust is a Professional Hazard!” – Jonathan Marks



Be more than a “Skeptoid.” . . . Verify. Fraud is not about obstruction; it is about deception!



“Trust is a Professional Hazard!” – Jonathan Marks



Closing Thoughts



•



• • • •



Regardless of an organization’s industry, size, or fraud scheme used, the majority of fraud is still detected by accident or tip. (ACFE 2010 and 2008 R Reports t to t the th Nation) N ti ) Clear need for a proactive approach to fraud deterrence and detection Go beyond skeptical and verify verify, Be curious, and have courage! Trust is a professional hazard---verify, verify, verify, and verify!



Thought Leadership “Putting the Freud in Fraud: Focus on the Human Element” by Jonathan Marks



Jonathan Marks, CPA/CFF, CFE, CITP Twitter: jtmarkscpa htt // http://www.linkedin.com/in/jonathantmarks li k di /i /j th t k [email protected] jonathan marks@crowehorwath com Mobile: 267-261-4947 Office: 212-572-5576 “Trust is a Professional Hazard!” – Jonathan Marks