ACC 555 Exam 1: Study Guide

In order to win an award for damages, the injured party must generally prove two points:

(1) liability - that the other party was liable for all or part of the damages claimed, and (2) damages - that the injured party suffered damages as the results of the actions or lack of actions of the offending party.

The Sarbanes-Oxley Act of 2002

*Addresses corporate governance and accountability as well as public accounting responsibilities in improving the quality, reliability, integrity, and transparency of financial reports. * Higher standards for corporate governance and accountability Creation of an independent regulatory framework Enhance quality and transparency of financial reports Severe civil and criminal penalties for corporate wrongdoers New protections for corporate whistleblowers

Donald R. Cressey & Cressey's Hypothesis

*Cressey's Hypothesis:* "Trusted persons become trust violators when they conceive of themselves as having a financial problem that is nonshareable, are aware this problem can be secretly resolved by violation of the position of financial trust and are able to apply to their own conducdt in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property." *This later became the fraud triangle*

Terrorism Triangle

*Opportunity* Most important to investigators because without opportunity to generate, move and control cash flows, the financing of terror cannot occur *Ideological Motivation* Terrorists have inherent motivation to inflict terror *Ideological Rationalization* Terrorists rationalize their activities based on their ideological beliefs

Fraud Triangle

*Opportunity* Whether the issue is management override related to a financial statement fraud, or a breakdown in the internal control environment that allows the accounts receivable clerk to abscond with the cash and checks of a business, the perpetrator needs the opportunity to commit a fraud. Further, when it comes to fraud prevention and deterrence, most accountants tend to direct their efforts toward minimizing opportunity through the internal control environment. However, internal controls are just one element of opportunity. Other integral ways to reduce opportunity include providing adequate training and supervision of personnel, effective monitoring of company management by auditors, audit committees and boards of directors, proactive anti-fraud programs, a strong ethical culture, anonymous hotlines and whistle-blower protections. *Pressure* It is a perceived pressure that causes an individual to seriously consider availing themselves of the opportunity presented by, for example, an internal control weakness. Fraud pressures can arise from financial problems, such as living beyond one's means, greed, high debt, poor credit, family medical bills investment losses or children's educational expenses. Pressures may also arise from vices such as gambling, drugs or an extramarital affair. *Rationalization*

SEC

*Securities & Exchange Commission* The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. SOX has authorized the SEC to issue implementation rules on many of its provisions intended to improve corporate governance, financial reporting and audit functions.

COSO

*The Committee of Sponsoring Organizations* of the Treadway Commission (COSO) -Joint initiative of the five private sector organizations listed on the left and is dedicated to providing thought leadership through the development of frameworks and guidance on enterprise risk management, internal control and fraud deterrence. *COSO's Enterprise Risk Management Framework (ERM)* Enterprise risk management (ERM) in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the organization's objectives (risks and opportunities), assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring progress. By identifying and proactively addressing risks and opportunities, business enterprises protect and create value for their stakeholders, including owners, employees, customers, regulators, and society overall.

The Fourth Amendment

*The Fourth Amendment prohibits unreasonable searches and seizures. The 4th Amendment protects individuals against unreasonable searches and seizures. First, unreasonable searches and seizures are forbidden.* All warrants for searches and arrest must be supported by probable cause and all warrants must be reasonably specific as to persons, places and things.[1] The overriding rule is that individuals have a "reasonable expectation of privacy." Whether a search or surveillance is reasonable is generally based on the totality of the circumstances. A search warrant based on probable cause has the effect of being reasonable. A major exception to the need for a warrant is where law enforcement has reason to believe that a crime has been committed (or about to be) and an immediate search is required. Fourth Amendment protections are further refined in specific circumstances as follows. -First public employers, e.g., government, are not required to obtain a search warrant when they conduct workplace searches for investigations of workplace misconduct. -The issue is that workplace investigations are substantially different than those conducted by law enforcement because the goal is not law enforcement but rather efficient office operations, a premise upheld by the U.S. Supreme Court. -Further, while individuals have a reasonable expectation of privacy in many places such as homes and automobiles, such an expectation does not apply in the workplace. -For example items of a personal nature may be left at home and need not be stored in the confines of an office, desk or filing cabinet. A workplace search is considered reasonable under two circumstances: - The search must be justified at its inception because it is likely to reveal evidence of work-related misconduct. The requirement implies that a clear suspicion exists based on a preliminary review of the evidence. - The search is necessary to further the investigation. An example of this concept is that the investigator is able to obtain files that are a required part of the investigation. The requirement implies that the search is likely to reveal pertinent information. Assuming that the search is reasonable based on these criteria the scope of the search must be no broader than is necessary to serve the organization's legitimate, work-related purpose. The investigator may, in fact, have no search limitations if the employee has no reasonable expectation of privacy in the place to be searched. For example a general filing cabinet with travel reimbursement forms has no reasonable expectation of privacy whereas the individual's desk is much more likely to yield items of a personal nature. Thus many workplace areas have no reasonable expectation of privacy for any employee. The key factor is "exclusive control." If the individual has exclusive control over a particular area, a reasonable expectation of privacy is more likely to become an issue. As noted above, even with exclusive control, the only standard that an employer must meet is that the search is reasonable based on the above guidelines. Search of motor vehicles including cars, truck, watercraft and airplanes may be conducted without a warrant if the law enforcement personnel believe that contraband is present or the vehicle contains other evidence of a crime. The risk of flight with regard to motorized vehicles makes them inherently more risky. Once moved evidence may be removed or destroyed and such a risk necessitates prompt action. In addition, unlike a home where expectation of privacy is paramount, motorized vehicles are subject to a much lower expectation. The motorized vehicle may be moved to a police facility and inventoried prior to search and proceed with the search without a warrant. The ability to search vehicles also applies to the contents of the vehicle (e.g., luggage) but does not extend to passengers. Passengers may not be searched without a prior arrest or warrant. Individuals may waive their 4th Amendment rights that prevent certain types of searches. Consent by an individual eliminates the need for a search warrant by law enforcement. Like confessions, the waiver of this right will be scrutinized to ensure that is was not coerced in any way. Thus law enforcement personnel must be able to defend the waiver against claims of false imprisonment, force, violence, limitations of ability to leave the area as well as accusations of deceit, bribery or misrepresentations. Unlike the Miranda Warning related to statements, no such warning must be made regarding an individual's right to refuse a search. Illegally obtained evidence may not be introduced in court. Furthermore, any information derived from illegal evidence cannot be introduced. This is known as "fruit from the forbidden tree."

RICO

*racketeering influence and corrupt organizations act * -addresses organizations involved in criminal activity 1) Outlaw investing illegal funds in another business 2) Outlaw acquisition of a business through illegal acts 3) Outlaw the conduct of business affairs with funds derived from illegal acts

Composition of Audit Committee

-Each member must be Board member-At least one member a "financial expert"

The legal standard for negligence has five elements:

1) Duty - A duty to act exists between the parties; 2) Breach - A determination that the defendant failed to use ordinary or reasonable care in the exercise of that duty; 3) Cause In Fact - An actual connection between the defendant's breach of duty and the plaintiff's harm can be established; 4) Proximate Cause - The defendant must have been the proximate cause or contributed to the injury to the plaintiff; 5) Damages - The plaintiff must establish that damages resulted from the defendant's breach of duty.

Cressey: Perceived Opportunity's Two Components

1) General information -Knowledge that the employee's position of trust could be violated (being aware that they are in a position to take advantage of employer's faith 2) Technical skill -Ability to commit violation -Usually same ability that employee needs to obtain job in the first place

The 5 Step Approach to Fraud Prevention, Deterrence and Detection

1) Know the exposures (brainstorming, risk assessment, audit planning) 2) Translate exposure into likely symptoms 3) Always be on the lookout for symptoms 4) Build audit and data mining programs to look for symptoms 5) Pursue these issues to their logical conclusion and ground decisions in the evidence (evidence-based decision making)

Legal Elements of Fraud (4)

A material false statement Knowledge that the statement was false when it was spoken Reliance on the false statement by the victim Damages resulting from the victim's reliance on the false statement

Fraud Examination Overview

A methodology for resolving fraud allegations from inception to disposition, including obtaining evidence, interviewing, writing reports and testifying. Requires that all fraud allegations be handled in a uniform, legal fashion and that they be resolved in a timely manner. Specific steps are employed in a logical progression designed to narrow the focus of the inquiry from the general to the specific, eventually centering on a final conclusion.

Tort

A private or civil wrong or injury, other than breach of contract, for which the law will provide a remedy in the form of an action for damages

Mail Fraud

A scheme to defraud someone by fraudulent pretenses and such fraud takes place in any U.S. Post Office, U.S. Mail depository or through transport by the U.S. Postal Service -Person needs only to cause the mail service to be used to facilitate the fraud act and the item sent or delivered may be transported by private or commercial carrier in furtherance of the fraud act -Punishable by a fine of $1 million and 30-year imprisonment

The AICPA (Be vaguely familiar)

AICPA has authority to set standards and make rules relating to: 1) Auditing standards for non-public companies -Reasonable assurance -Professional skepticism 2) Compilation and review standards 3) Other attestation standards 4) Consulting standards 5) Code of professional conduct *While the FASB develops generally accepted accounting principles, the purview of auditing of non-public companies falls under the guidelines of the American Institute of Certified Public Accountants (AICPA).*

Elements of Fraud (3)

Act Concealment Conversion While the fraud triangle provides an effective explanation for the conditions necessary for fraud to occur and is a source of red flags that require investigation, in order to prove fraud, the investigator has to deal with the problem of intent. Intent, like all aspects of the investigation must be grounded in the evidence. In a fraud case, the challenge is that short of a confession by a co-conspirator or the perpetrator, evidence of intent tends to be circumstantial. Although less famous than the fraud triangle, the elements of fraud are critical to the investigative process, whether the engagement includes fraud or litigation issues. The elements of fraud include the act (e.g., fraud act, tort, breach of contract), the concealment (hiding the act or masking it to look like something different) and the conversion (the benefit to the perpetrator).

Four common elements of Occupational Fraud and Abuse

Activity is clandestine Violates the employee's fiduciary duties to organization Committed for the purpose of direct or indirect financial benefit to the employee Costs the employing organization asses, revenues, or reserves

Schemes and Illegal Acts Associated with Complex Frauds and Financial Crimes

Align more with predators than the accidental fraudster Motivation and intent is nefarious and deliberate Mode of operation is more sophisticated Perpetrators often collude with others Tend to be sophisticated and very disciplined Make full use of technology

Negligence

Another tort—negligence—applies when the conduct of one party did not live up to minimal standards of care. Each person has a duty to act in a reasonable and prudent manner. When individuals or entities fail to live up to this standard, they are considered "negligent."

The Rights of Individuals

As employees, individuals have an obligation to cooperate with their employer or be subject to dismissal. Other rights may be granted to employees as set out in employment contracts and collective bargaining agreements. Federal law and many state laws protect employees who report improper or illegal acts of their employer or to the government. Such laws normally protect the employee against overt retaliatory or punitive action by the employer, although as a practical matter subtle forms of discrimination are hard to combat.

Searches: Surveillance

Audio surveillance laws and regulations are more complicated -"One-party consent" -Stored communications not as protected, especially at work Video surveillance generally permissible -As long as there is no audio associated with it *Generally video surveillance is permissible as long as it does not violate a person's reasonable expectation of privacy. Anyone in a public park, parking lot, or mall may be video-taped without violating any laws as long as no audio of the target is recorded.*

Bankruptcy Fraud

Bankruptcy fraud includes schemes to file a false bankruptcy petition, file documents during a proceeding or make false or fraudulent statements, representations, claims or promises before or after the filing of a bankruptcy petition Bankruptcy crimes are investigated by the FBI and prosecuted by the U.S. Attorneys Office What is the role of the trustee -When allegations of fraud or misconduct may be present -Attempts to identify missing assets and locate them (reconstruct cash receipts and cash disbursements, identify new bank accounts, interview key personnel

Interviews

Because employers do not have the right to place employees in a custodial setting, an employee has limited 5th Amendment rights. *However public employers are held to a higher standard and their employees can invoke their 5th Amendment protections without fear of reprisal.* A second issue arises with interviewees with regard to the 6th Amendment where employees are entitled to legal counsel. *As long as a non-public entity is conducting the interview an employee does not have the right to have a lawyer present nor does the employee have the right to consult their attorney prior to an interview.* However, the employee maintains the right to consult an attorney if they request one. *With regard to the 14th Amendment, private employers do not have to offer employees due process of law.* In contrast, law enforcement and public entities have such an obligation under this amendment. For example federal employees may have a right of notice of charges and may have the right to rebut any charges put forward. Miranda warnings -Right to remain silent -Answers can be used against him -Right to an attorney -If interviewee can't afford an attorney, one will be provided at no cost 6th/14th Amendment protection - -Legal counsel and due process if public person conducts interview -Private employers don't have to offer due process of law Common law protections

Chapter 7 Bankruptcy

Chapter 7 deals with the liquidation of the debtors assets, including individuals and businesses

Common Securities Fraud Schemes: Churning

Churning is the excessive sale of securities by a broker for the purposes of generating commissions. To prove churning, the alleged victim must prove that the broker controlled the trading in the account that the volume of activity was excessively high when compared to the investors trading objectives and the broker acted with intent to defraud or with reckless disregard for the investor's interests. According to the ACFE Fraud Examiners Manual, the best method to evaluating a claim of churning is to calculate the percentage of monthly commissions generated from the average account balance.

Edwin H. Sutherland & the Theory of differential association

Coined the term white-collar crime Theory of differential association -Basic tenet is that *crime is learned* -Learning of criminal behavior occurred with other persons in a process of communication -*Criminality can't occur without the assistance of other people* -Learning of criminal activity usually occurred within intimate personal groups -Techniques to commit a crime -Attitudes, drives rationalizations, motives of criminal mind

Corruption Schemes

Collusive is both collusive and predatory Include bribery, illegal gratuities, economic extortion, and conflicts of interest At least one party and possibly all parties, set out to achieve certain goals as a result of their activities Corruption includes bribery, illegal gratuities, economic extortion and conflicts of interest. Corruption is collusive by its very nature and tends to be predatory.

Physician-patient privilege

Confidential when obtaining treatment or being diagnosed When involved in litigation, privilege is waived -Court appointed physicians -Expert witnesses

Cressey & Non-Shareable Problems

Cressey found that the non-shareable problems arose from situations that could be divided into six basic categories, all of which dealt with subject seeking or maintaining status: 1) *violation of ascribed obligations* - implied duty to act in a way becoming of the position the person holds 2) *problems resulting from personal failure* - problem caused by you and person feels personally responsible 3) *business reversals* - outside forces caused problem 4) *physical isolation* - there is no one to turn to 5) *status gaining* - "keeping us with the Joneses" 6) *employer-employee relations* - resent status in organization but has no choice but to stay in job

The importance of non-financial data:

Data from any source outside of the financial reporting system that can be used to generate an alternative view of the business operation Break the financial numbers into p's (prices) and q's (quantities) and examine the numbers for evidentiary support and reasonableness.

Demonstrative Evidence

Demonstrative evidence purports to educate, summarize or amplify real evidence (e.g., photos, videos, charts, diagrams, animations, experiments) -Tells a story or complements other evidence -Must not create prejudice -Heart of most fraud and forensic accounting investigations

Money Laundering

Disguising the existence, nature, source, ownership, and location of assets derived from criminal activity (making dirty money look clean Money laundering takes place in 3 stages -Placement -Layering -Integration *Ultimately, the money must start and end at the same place (find the beneficiary, find the criminal)*

Drug Trafficking

Drug trafficking is a specific example of an organized criminal organization Defined as the dealing of narcotics for illegal sale in countries all over the world Countries form partnerships to tackle illegal drug problems Illegal drug trafficking costs the US at least $70 billion annually Probability of detecting drugs drop considerably once they enter the US Bilateral and multilateral counter-narcotics efforts are the key effective response to fighting drug trafficking

Utilitarian Principle

Ethical problems should be solved by weighing the good and bad consequences and going with what provides the most good or the least bad. The "act" supersedes the "rule"

Rules of Evidence (6)

Evidence is anything legally presented at trial to prove a contention and convince a jury -Must be relevant and trustworthy -Must be admissible -May be testimonial -Real (e.g., documents) or demonstrative -Circumstantial or Direct (e.g., eyewitness) -"Facts at issue" are supported by the evidence -Fingerprints at a location is evidence that the defendant was at that location (fact at issue)

Schemes & Illegal Acts (List: 7)

FS Fraud Corruption Organized Crime Drug Trafficking Terrorism Financing Money Laundering Racketeering (RICO)

Financial Forensics

Financial forensics is the application of financial principles and theories to facts or hypotheses at issue in a legal dispute. Consists of two primary functions: (a) litigation advisory services, which recognizes the role of the financial forensic professional as an expert or consultant and (b) investigative services, which makes use of the financial forensic professional's skills and may or may not lead to courtroom testimony.

To prove money laundering, the government must demonstrate:

Financial transaction was attempted or conducted Defendant knew the proceeds derived from unlawful act Property derived from a specified unlawful act Defendant attempted to accomplish one of the following objectives -Promote a specified unlawful act (SUA) -Conceal the nature, source, location, ownership or control the proceeds of an SUA -Attempted to avoid federal reporting requirements -Attempted to evade taxes

Fraud Detection

Fraud detection refers to the process of discovering the presence or existence of fraud. Fraud detection can be accomplished through the use of well designed internal controls, supervision and monitoring and the active search for evidence of potential fraud.

The Perception of Detection

Fraud deterrence begins in the employee's mind. Employees who perceive that they will be caught are less likely to engage in fraudulent conduct. The logic is hard to dispute. Exactly how much deterrent effect this concept provides will be dependent on a number of factors, both internal and external. But internal controls can have a deterrent effect only when the employee perceives such a control exists and is for the purpose of uncovering fraud. "Hidden" controls have no deterrent effect. Conversely, controls that are not even in place—but are perceived to be—will have the same deterrent value.

Fraud Deterrence

Fraud deterrence refers to creating environments in which people are discouraged from committing fraud, although it is still possible.

Fraud Investigation

Fraud investigation takes place when indicators of fraud, such as missing cash or other evidence, suggest that a fraudulent act has occurred and requires investigation to determine the extent of the losses and the identity of the perpetrator.

The Costs of Fraud and Litigation

Fraud losses tended to rise based on the perpetrator's level of authority within an organization. Generally, employees with the highest levels of authority are the highest paid as well. While the median loss in schemes committed by those earning between $200,000 and $499,999 annually reached $1 million, the median loss skyrocketed to $50 million for executive/owners earning more than $500,000 per year. Other -As education rose, so did cost -As collusion occurred, so did cost -As tenure lengthened, so did cost -Less than 7% of the perpetrators identified in the 2008 study were known to have been convicted of a previous fraud-related offense -small organizations tend to suffer disproportionately large fraud losses

Fraud Prevention

Fraud prevention refers to creating and maintaining environments where the risk of a particular fraudulent activity is minimal and opportunity is eliminated, given the inherent cost-benefit trade-off. When fraud is prevented, potential victims avoid the costs associated with detection and investigation.

Fraud

Fraud, sometimes referred to as the fraudulent act, is an intentional deception, whether by omission or co-mission, that causes its victim to suffer an economic loss and/or the perpetrator to realize a gain.

Common Securities Fraud Schemes: Front Running

Front running is a derivation of insider trading. The perpetrator, possibly a back office clerk or exchange floor order filler becomes aware of a large buy or sell order, a trade large enough to move the market. In advance of executing the large order, the perpetrator makes a trade in his or her account so as to benefit from the large order trade and the subsequent movement in the market.

Money Laundering: Layering

Hiding or disguising true source of money

USA Patriot Act

Identified new types of money laundering crimes and increased the penalties associated with them Set out procedure for the forfeiture of bulk cash (>$10,000) that had been smuggled Permits the confiscation of all property of an individual or entity who participates in the planning of a terrorist attack Prohibits US financial institutions from allowing correspondent account transactions with shell banks

Generalization Principle

If all relevantly similar persons acting under relevantly similar circumstances were to act a certain way and the consequences would be undesirable, then no one ought to act in that way without a reason

Common Securities Fraud Schemes: Pyramid Schemes

In a pyramid scheme, fees or dues are paid by new members to join the organization. The new member, upon joining, is expected to attract and sign up new members and collect their membership fees on behalf of the organization. The organization generates cash flow, not by selling goods and services to clientele but by the collection of membership fees from new members. The membership fees are then distributed in part to the old members as a form of return on investment (e.g., dividend) to keep the old members attracting new members and to keep the scheme from collapsing. The scheme is depend, not only on the distribution of cash to old members but the solicitation of new members and the collection of their membership fees as a source of funding distributions to old members. If either the old members fail to see returns on investment or the old members fail to solicit and sign up new members, the scheme collapses, as they all invariably due.

Conversion

Individual takes possession of property or personal chattel that does not belong to them Alteration of condition or exclusion of owner's rights The employee might also be accused of having committed a tort known as conversion. Conversion, in the legal sense, is "an unauthorized assumption and exercise of the right of ownership over goods or personal chattels belonging to another, to the alteration of their condition or the exclusion of the owner's rights." A person commits a conversion when he takes possession of property that does not belong to him and thereby deprives the true owner of the property for any length of time. The employee in our example took possession of the computer chips when he stole them, and by selling them he has deprived his employer of that property. Therefore, the employee has also engaged in conversion of the company's property.

Money Laundering: Placement

Initial stage of placing money into financial system (using cash based businesses, offshore accounts)

Privileges

Legal privileges are protections against certain types of testimony. With the exception of the privilege against compelled self-incrimination, most of the following privileges are not constitutionally based: >Attorney-client privilege >Attorney work-product privilege >Physician-patient privilege >Marital privileges

Dr. Steve Albrecht: Top Perpetrator Characteristics

Living beyond their means Overwhelming desire for personal gain High personal debt Close association with customers Feeling pay not commensurate with responsibility Wheeler-dealer attitude Strong challenge to beat the system Excessive gambling habits Undue family or peer pressure No recognition for job performance

M.I.C.E Acronym

M - Money I - Ideology C - Coercion E - Ego *Money & Ego are the two most commonly observed. *Enron, WorldCom, Adelphia, Phar-Mor, ZZZ Best provide good examples where the convicted perpetrators seemed to be motivated by greed (money) and power (ego). *Ideology is probably the least frequent motivation for white collar crime, *but society has seen this with terrorism financing. With ideology, the end justifies the means and perpetrators steal money to achieve some perceived greater good that furthers their cause.

Common Law Protections (Ties into Interviews)

Minimization of invasion of employee's privacy Limitations on interview content to employee's job duties and responsibilities Limitations on public disclosure of employee's private facts Limitations on intentional infliction of emotional stress on employee Limitations on defamation - unfounded facts and accusations made by the interviewer A duty to deal fairly and in good faith No false imprisonment (could be defined as size, nature, lighting of the room, amount of force involved, any violent behavior by interviewer, limitations of ability to leave interview room, number of persons involved

Fraud Risk Factors

Motivational - Is management focused on short term results or personal gain? Situational - Is there ample opportunity for fraud? Behavioral - Is there a company culture for a high tolerance of risk?

Requirements for Valid Confessions (3)

Must be determined to be voluntary Cannot be obtained as a result of coercion or under threat of violence Can be nullified if interviewer promises leniency

Organizational Crime

Occurs when entities, companies, corporations, non-for-profits, non-profits and government bodies, otherwise legitimate and law abiding organizations, are involved in a criminal offense Often consists of unfair pricing, unfair business practices, and tax evasion Organizations can be prosecuted in a similar manner to individuals Common examples are money laundering, mail and wire fraud, conspiracy and racketeering

Criminal Justice Penalties: Parole

Once a sentence has been fulfilled or is shortened for good behavior, the person is typically placed on parole. Parole is often used as a reward for good behavior during time served. During the parole period, a parole officer is assigned.

Organized Crime

Organized Crime Control Act of 1970 Unlawful activities of... a highly organized, disciplined association Many organizations involved in organized crime are professionally run -Opportunistic -Diversified -Require political support -Capital Investment Annual impact of organized crime profits to be approximately $1 trillion Racketeering is the act of engaging in criminal activity as a structured act Manipulate and monopolize financial markets, especially in less developed areas of world Infiltrate labor unions Align itself with traditional businesses (e.g., construction and trash collection) Purchase political support through bribery, extortion, blackmail, intimidation and murder Understanding the storyline (who, what, when, where, how, and why) and the flow of money provide a solid investigative approach for case development

White-Collar Crime

Originally defined as "Crime in the upper, white-collar class, which is composed of respectable, or at least respected, business and professional men" Often used interchangeably with occupational fraud and economic crime -Though crimes for money also include murder, burglary, and drug trafficking - non-white collar Typically associated with an abuse of power

Common Securities Fraud Schemes: Parking

Parking is a technique used by an investor to avoid ownership reporting requirements and net capital rules. The parking investor sells the security to another individual with the intent and ability to repurchase the security at a later date with the intent of avoiding ownership reporting requirements and net capital rules.

Cressey's Study: Obsconders

People who take the money and run are usually ones who are physically isolated Usually unmarried or separated from their spouses, have few primary group associations and own little property Tend to have lower occupational and socio-economic status that previous 2 categories Absconders find it easy to define a problem as "nonshareable (perceived opportunity) and don't care what happens to themselves (rationalization)

Cressey's Study: Independent Businessmen

Persons who were in business for themselves and who converted deposits which had been entrusted to them Perpetrators in this category use 1 of 2 common excuses -They were "borrowing" the money they converted -The funds entrusted to them were really theirs Almost universally felt their illegal actions were predicated by an "unusual situation", in other words a "nonshareable financial problem"

Tax Evasion and Tax Fraud

Primary distinction whether an individual has committed tax fraud or just committed an error is *intent* Tax Evasion is the intentional wrongdoing to evade taxes believed to be owed -Requires at least one "affirmative act" or deliberate acts to conceal to demonstrate intent (e.g., deliberate understatement, omission of taxable transactions, false statements to tax agents or false documentation -One defense is an objectively reasonable "good faith" misunderstanding of law

Criminal Justice Penalties: Probation

Probation is a penalty and is used as an alternative to prison, whereas parole is used to describe the corrections process subsequent to having served time in prison.

Attorney work-product privilege

Protects all materials prepared by an attorney in anticipation of litigation Shield materials that would disclose attorney's theory of the case Any written materials directed toward preparation of a case Must be prepared in anticipation of litigation

PCAOB

Public Company Accounting Oversight Board The PCAOB is a nonprofit corporation established by Congress to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports. The PCAOB also oversees the audits of broker-dealers, including compliance reports filed pursuant to federal securities laws, to promote investor protection.

Racketeering Influence and Corrupt Organizations Act (R.I.C.O.)

Racketeering: obtaining or extorting money illegally or carrying on illegal business activities, usually by Organized Crime Addresses the organizations involved in making dirty money clean Original goal was to allow investigators to go after businesses and other entities involved in organized crime Essentially, RICO makes it illegal for any person who has received funds that derived directly or indirectly from a pattern of racketeering to invest or acquire any other business that is involved in interstate or foreign commerce RICO also provides for the forfeiture of assets used in racketeering crimes and permits treble damages in civil cases

Real Evidence

Real evidence "speaks for itself" -Does not require explanatory testimony -Must be authenticated (i.e., collected properly, preserved without damage or alteration, and identifiable as it moves through judicial system (chain of custody)

Criminal Justice Penalties: Recidivism

Recidivism refers to the process where a formerly convicted person re-enters the criminal justice system.

Professional Skepticism

Recognition that fraud may be present. An attitude that includes a questioning mind and a critical assessment of the evidence. A commitment to persuasive evidence At a minimum, professional skepticism is a neutral, but disciplined approach to detection and investigation. SAS No. 1 suggests that an auditor neither assumes that management is dishonest nor assumes unquestioned honesty. In practice, professional skepticism, particularly recognition, requires that the fraud examiner or forensic accountant "pull on a thread."

Chapter 9 Bankruptcy

Reorganization. Chapter 9 applies to municipalities

Dr. Steve Albrecht & The Fraud Scale

Reviewed 212 frauds in the early 1980s and interviewed internal auditors who investigated these frauds Assembled a complete list of pressure, opportunity, and integrity variables Created a list of 50 possible indicators of occupational fraud and abuse Variables fell into 2 principle categories -Perpetrator characteristics -Organizational environment Developed the "Fraud Scale"

Statement on Auditing Standards No. 99

SAS No. 99 offers an 8-step approach when considering the risk of materially misstated financial statements due to fraud. Risk of materially misstated financial statements 1) Undertake analysis of fraud risks 2) Gather information relating to fraud risks 3) Consider impact and likelihood for fraud risks 4) Consider programs and controls to mitigate risk 5) Develop specific responses to fraud risks (testing, amount of evidence, etc.) 6) Assess fraud risk throughout the audit 7) Communicate fraud to specific levels of management - material fraud to senior management/ audit committee 8) Document work done in consideration of fraud

Breach of Fiduciary Duty

Someone who acts in the benefit of others Normally officers and directors of company We might also observe that some employees have a recognized fiduciary relationship with their employers under the law. The term fiduciary, according to Black's Law Dictionary, is of Roman origin and means "a person holding a character analogous to a trustee, in respect to the trust and confidence involved in it and the scrupulous good faith and candor which it requires. A person is said to act in a 'fiduciary capacity' when the business which he transacts, or the money or property which he handles, is not for his own benefit, but for another person, as to whom he stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part." In short, a fiduciary is someone who acts for the benefit of another. A fiduciary has a duty to act in the best interests of the person whom he represents. When he or she violates this duty, the person can be liable under the tort of breach of fiduciary duty. The elements of this cause of action vary among jurisdictions, but in general they consist of the following: (1) a fiduciary relationship between the plaintiff and the defendant; (2) the defendant (fiduciary) breached his duty to the plaintiff; and (3) the breach resulted in either harm to the plaintiff or benefit to the fiduciary.

Marital privileges

Spousal immunity - doesn't exist in every state -Protection from testifying against own spouse Spousal defendant - slight majority of states allow -Protection from adverse testimony -Allowed in both civil and criminal cases -Covers statements made during marriage Neither applies to crimes or torts within family

The Hypothesis-Evidence Matrix: The Analysis of Competing Hypotheses

Steps: 1) Analyze available data 2) Create hypotheses 3) Test the hypotheses 4) Refine and amend the hypothesis 5) Draw conclusions *Analyzing the Evidence* If an audit of the entire purchasing function was deemed appropriate, it would be conducted at this time and would specifically focus on the possibility of fraud resulting from the anonymous allegation. A fraud examiner would look, for example, at how contracts are awarded and at the distribution of contracts among Bailey Books' suppliers. *Creating the Hypotheses* Based on the caller's accusations, you would develop several hypotheses to focus your efforts. The hypotheses range from the null hypothesis that "nothing illegal is occurring" to a "worst-case" scenario. That is, with the limited information you possess, what is the worst possible outcome? In this case, for Bailey Books, it would probably be that its purchasing manager was accepting kickbacks to steer business to a particular vendor. A hypothesis can be created for any specific allegation, i.e., a bribery or kickback scheme, embezzlement, conflict of interest, or financial statement fraud where evidence indicates that the hypothesis is a reasonable possibility. *Testing the Hypotheses* Once the hypotheses have been developed, each must be tested. This involves developing a "what if" scenario and gathering evidence in support of or to disprove the proposition. For example, if a purchasing manager like Linda Reed Collins were being bribed, a fraud examiner likely would find some or all of the following facts: A personal relationship between Collins and a vendor Ability of Collins to steer business toward a favored vendor Higher prices and/or lower quality for the product or service being purchased Excessive personal spending by Collins In the hypothetical case of Linda Reed Collins, you—using Bailey Books' own records—can readily establish whether or not one vendor is receiving a larger proportional share of the business than similar vendors. You could ascertain whether or not Bailey Books was paying too much for a particular product, such as paper, by simply calling other vendors and determining competitive pricing. Purchasing managers don't usually accept offers of kickbacks from total strangers; a personal relationship with any suspected vendor and the buyer could be confirmed by discreet observation or inquiry. Whether or not Collins has the ability to steer business toward a favored vendor could be determined by reviewing the company's internal controls to ascertain who is involved in the decision-making process. The proceeds of illegal income are not normally horded; the money is typically spent. Collins' lifestyle and spending habits could be determined through examination of public documents such as real estate records and automobile liens. *Refining and Amending the Hypotheses* In testing the hypotheses, a fraud examiner or forensic accountant might find that all facts do not fit a particular scenario. If such is the case, the hypothesis should be revised and retested. In some cases, hypotheses will be discarded entirely. In such cases, the professional should maintain an evidence trail for the discarded hypothesis that demonstrates what evidence was used to suggest that the hypothesis was not supported. Gradually, as the process is repeated and the hypotheses continue to be revised, you work toward what is the most likely and supportable conclusion. The goal is not to "pin" the crime on a particular individual, but rather to determine, through the methodical process of testing and revision, whether a crime has been committed, and if so, how.

Other Findings of Hollinger and Clark

Substantially increasing the internal security presence does not seem appropriate Employees who engage in workplace deviance also engage in employee theft If ways to reduce employee theft do not reduce its underlying cause may create more detrimental activities like productivity Management sensitivity to employees would reduce workplace deviance Special attention should be afforded young employees

Hollinger and Clark

Surveyed 10,000 American workers for their book "Theft by Employees". The two researchers reached a different conclusion than Cressey. They found that employees steal primarily as a result of workplace conditions. They also concluded that the true costs of employee theft are vastly understated: "In sum, when we take into consideration the incalculable social costs . . . the grand total paid for theft in the workplace is no doubt grossly underestimated by the available financial estimates. In reviewing the literature on employee theft, Hollinger and Clark noted that experts had developed five separate but interrelated sets of hypotheses to explain employee theft. The fourth theory was that job dissatisfaction is the primary cause of employee theft, and the fifth was that theft occurs because of the broadly shared formal and informal structure of organizations. That is, over time, the group norms — good or bad — become the standard of conduct. *The sum of their research led Hollinger and Clark to conclude that the fourth hypothesis was correct, that employee deviance is primarily caused by job dissatisfaction.* Hypotheses of Employee Theft -Found that employees steal primarily as a result of workplace conditions -True costs of employee theft are vastly understated Employee Deviance Income and Theft Age and Theft Position and Theft Job Satisfaction and Deviance Organizational Controls and Deviance Employee Perception of Control

Cressey's Study: Long-Term Violators

Take small amounts of funds from employer or employer's client over time -Similar to the "borrowing" idea of the independent businessmen group -Employers cheating them and deserved it More difficult to return funds than to steal them because they would be detected Most perpetrators wanted to "clean the slate" and repay their debt Perpetrators often feared losing social position not possibility of punishment At some point long-term violators understand they are in too deep -When they felt they were "borrowing" self-image as a law abiding citizen maintained -Ultimately, perpetrator realizes they committed a crime -Conflict creates anxiety - are they good people or are they criminals? At this point they have two options -Readopt attitudes of law-abiding citizens -Adopt the attitudes of criminals and take larger sums

Imperative Principle

Tends to ignore outcomes by providing directives and rules without exception that are in the best interest of society as a whole Assumes all people are aware and agree to follow rules

Terrorism Financing

Terror organizations need funds to operate Terrorism designed to intimidate or coerce persons or governments through force or violence Goal is to deny terrorist groups access to the international banking system to impair ability to raise funds Primary sources of terrorist financing -State (Government) sponsorship: North Korea, Syria. Iran -Revenue generation from legitimate (investments, charities) and illegitimate activities (kidnapping, extortion) Terrorists place money without attracting attention (less restrictive overseas banks, money laundering)

Male vs Female Cost of Fraud

The 2008 ACFE Report to the Nation showed that male employees caused median losses more than twice as large as those of female employees; the median loss in a scheme caused by a male employee was $250,000, while the median loss caused by a female employee was $110,000. Mainly due to males having higher paying jobs.

Bank Secrecy Act

The BSA was passed to assist in the investigation of illegal acts associated with drug trafficking and tax evasion Attacks the placement stage of money laundering process, where fraudster is most vulnerable Any currency transaction of more than $10,000 must be reported to the Department of the Treasury on the Currency Transaction Report (CTR) (CTRC for casinos) Requires that financial institutions maintain adequate records and that financial institutions report certain types of transactions to the federal government Transactions involving suspicious persons must be reported on the "Suspicious Activity Report (SAR)" Movement of more than $10,000 into or out of the U.S. must be filed on FinCen Form 105

The Fifth Amendment

The Fifth Amendment provides that a person cannot be compelled to provide incriminating information against himself.

The Fourteenth Amendment

The Fourteenth Amendment entitles a person to due process of law and equal protections under the law.

The Sixth Amendment

The Sixth Amendment provides that an individual has the right to an attorney to defend himself and the right to confront witnesses against him.

Elements of Conspiracy (3)

The co-conspirators must have an agreement between them The co-conspirators must act or demonstrate an inclination to commit a crime The participants must mentally commit to the act through their state of mind

Essential investigative tools:

The examination of financial statements, books and records, and supporting documents The interview: the process of obtaining relevant information about the matter from those with knowledge

Attorney-client privilege

The right to not disclose confidential communication relating to professional relationship Client has right to compel nondisclosure Applies only to communications intended to be confidential Does not permit attorney to conceal physical evidence Does not apply to future acts of crime or fraud

Predication

The totality of circumstances that would lead a reasonable, professionally trained, and prudent individual to believe a fraud has occurred, is occurring, and/or will occur. All fraud examinations must be based on proper predication; without it, a fraud examination should not be commenced.

Common Securities Fraud Schemes: Insider Trading

The use of non-public information by insiders with fiduciary responsibilities to their company and its shareholder to profit from the purchase and sale of security is illegal.

Occupational Fraud and Abuse

The use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets Common violations include asset misappropriation, corruption, pilferage, petty theft, and fictitious payroll

Wire Fraud

The use of wire, radio or television to communicate false or fraudulent pretenses, representations or promises Must be associated with interstate or foreign commerce for wire fraud statutes to apply Electronic communications may be writings, sign,s signals, pictures, or sounds to further the fraud scheme Violations are punishable by not more than a $1 million fine and up to 30 years of imprisonment

Criminal Justice Penalties: Discretion

To determine the severity and punishment of crime.

Dr. Steve Albrecht: Fraud Scale

To illustrate the concept, Albrecht developed the "Fraud Scale," which included the components of: situational pressures, perceived opportunities, and personal integrity. When situational pressures and perceived opportunities are high and personal integrity is low, occupational fraud is much more likely to occur than when the opposite is true. *Situational Pressures* the immediate problems individuals experience within their environments, the most overwhelming of which are probably high personal debts or financial losses." *Personal integrity * refers to the personal code of ethical behavior each person adopts. While this factor appears to be a straightforward determination of whether the person is honest or dishonest, moral development research indicates that the issue is more complex."

Searches

Unreasonable searches and seizures are forbidden by the Fourth Amendment Search warrants require probable cause and reasonably specific as to person, place or thing but different in workplace situations When is a workplace search reasonable? -Likely to reveal evidence of work-related misconduct -Search is necessary to further investigation Search limitations -"Exclusive control": does employee have exclusive control over a particular area -"Fruit from the forbidden tree": can't use evidence in improper search

Money Laundering: Integration

Using the money without risk of being associated with dirty money

Financial Statement Fraud

Usually a complex fraud Almost always involves the CFO, controller or some other sophisticated participant within financial reporting structure Executive level individuals work in concert to override the system of internal controls *It almost always involves the chief financial officer, controller or some other sophisticated participant within the financial reporting structure.* It also often involves top leadership in the organization such as the chief executive officer, chief operating officer, president or others with significant levels of authority. While not always predatory, at least at the time of inception, it is almost always collusive. Executive level individuals work in concert (collusively) to override the system of internal controls through the sophisticated use of journal entries, significant estimates and other financial reporting choices and through material unusual, one-time transactions.

Common Securities Fraud Schemes: Prime Bank Fraud

While this fraud scheme like most others has various derivations, usually, investors are promised high rates of return with little inherent risk by investing in "prime bank" notes. The underlying methodology is supposed to be an off-shore trading program which yields extremely high rates of return. The investment prospectus is usually confusing and makes reference to legitimate banks and recognized financial institutions from around the world. The prospective investor is usually required to sign a non-disclosure agreement. Of course, the entire investment is a sham and the investor will loose all of their money in the process.

What is Difference Between Fraud and Abuse?

Workplace Abuses -Using equipment belonging to an organization -Surfing the internet at work -Attend to personal business at work -Taking long lunch and coffee breaks, without approval -Coming to work late or leaving early -Using sick leave when not sick -Using employee discounts to purchase goods for friends and relatives -Working under the influence Abuses are generally smaller in nature and are not as malicious.

Embezzlement

Wrongdoer acquired lawfully Furthermore, the act of stealing the computer chips also makes the employee an embezzler. "To embezzle means willfully to take, or convert to one's own use, another's money or property of which the wrongdoer acquired possession lawfully, by reason of some office or employment or position of trust." *The key words in that definition are "acquired possession lawfully."* In order for an embezzlement to occur, the person who stole the property must have been entitled to possession of the property at the time of the theft. Remember, "possession" is not the same thing as "ownership." In our example, the employee might be entitled to possess the company's computer chips (to assemble them, pack them, store them, etc), but clearly the chips belong to the employer, not the employee. When the employee steals the chips, he has committed embezzlement.

Effective monitoring controls may help detect

collusive activity

In a fraud examination, evidence is usually gathered in a manner that moves from the

general to the specific

Hollinger and Clark: Employees who are dissatisfied with their jobs are...

most likely to seek redress through counterproductive or illegal behavior in order to right the perceived "inequity"

Tort of contract interference

parties not allowed freedom to contract without third party interference

With fraudulent representations such as materially misstated financial statements and improper tax returns, the investigator starts with the

suspected perpetrator. The logic of this is simple; assuming the person knowingly created false financial statements or tax returns, the act of falsifying is part of the concealment of the act. As such, inherently, the perpetrator has made one of the following assumptions: the auditor or investigator won't find the issue or if you identify red flags related to the issue, the auditor or investigator won't be smart enough to unravel the underlying evidence to determine what really happened. Essentially, the alleged perpetrator is betting his or her intellect against that of the auditor or investigator. Thus, by interviewing the suspected perpetrator at the inception of the audit, examination or investigation, you are documenting their claim(s) that the financial statements are not materially misstated or that the tax return properly reflects all items of taxable income. Thus, if the auditor finds fraudulent financial reporting, they have caught the perpetrators in a lie and have developed further evidence of concealment.

Red Flags

unexplained accounting anomalies exploited internal control weaknesses identified analytical anomalies where non-financial data do not correlate with financial data observed extravagant lifestyles observed unusual behaviors anomalies communicated via tips and complaints.