INTRODUCTION TO FRAUD EXAMINATION

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2 TABLE OF CONTENTS I. INTRODUCTION TO FRAUD EXAMINATION Introduction... 1 Axioms of Fraud Examination... 1 Fraud Is Hidden... 1 Reverse Proof... 1 Existence of Fraud... 2 Predication... 2 Fraud Theory Approach... 2 Analyzing Available Data... 2 Creating a Hypothesis... 3 Testing the Hypothesis... 3 Refining and Amending the Hypothesis... 3 Examination Methodology... 3 Interview... 3 Document Examination... 3 Observation... 4 Steps in a Fraud Examination... 4 Document Examination... 4 Neutral Third-Party Witnesses... 4 Corroborative Witnesses... 4 Co-conspirators... 4 Accused... 4 Review Questions... 5 II. FRAUD PREVENTION AND DETERRENCE: CAUSES OF FRAUD Classical Criminology... 7 Biological Theories... 7 Psychological Theories... 7 Social Process Theories... 8 Social Control Theory... 8 Social Learning Theory... 8 Integrated Theories... 8 Routine Activities Theory... 8 Anomie and Strain Theory... 8 Factors Affecting Traditional Crimes... 9 Age Trends... 9 Economics and Crime... 9 Gender and Crime Theories of Fraud Causation Donald R. Cressey Workplace Conditions Review Questions III. INVESTIGATION: PLANNING THE INVESTIGATION Introduction Initial Plan i

3 III. INVESTIGATION: PLANNING THE INVESTIGATION (CONT.) Discovery Process Document Collection and Examination Neutral Third-Party Witnesses Confirmation Process Interview of Corroborative Witnesses Interview of Co-conspirators Admission-Seeking Interview of the Suspect Conclusion Review Questions IV. LEGAL ELEMENTS: LEGAL ELEMENTS OF FRAUD Introduction Criminal Versus Civil Actions for Fraud Crime Tort The Elements of Fraud Misrepresentation How to Prove Intent or Knowledge Corporate Civil and Criminal Liability Common Civil and Criminal Actions for Fraud Misrepresentation of Material Facts Concealment of Material Facts Bribery Illegal Gratuity Economic Extortion Conflict of Interest Breach of Fiduciary Duty Theft of Money and Property Selected Criminal Statutes Federal Corruption Statutes (18 U.S.C. 201, et seq.) Mail Fraud and Wire Fraud Bank Fraud (18 U.S.C. 1344) Racketeer Influenced and Corrupt Organizations (18 U.S.C. 1961, et seq.) Computer Frauds (18 U.S.C. 1030) Economic Espionage Act of 1996 (18 U.S.C ) Securities Fraud Foreign Corrupt Practices Act (15 U.S.C. 78a(b), 78dd-1, 78dd-2, 78ff, 78m) Conspiracy to Defraud the United States (18 U.S.C. 371) False Claims and Statements Commercial Bribery Statutes Review Questions V. FRAUDULENT FINANCIAL TRANSACTIONS: MANAGEMENT S AND AUDITORS RESPONSIBILITIES Introduction Management s Responsibilities Code of Conduct ii

4 V. FRAUDULENT FINANCIAL TRANSACTIONS: MANAGEMENT S AND AUDITORS RESPONSIBILITIES (CONT.) Sarbanes-Oxley Audit Committee Responsibilities External Auditor s Responsibility Review Questions VI. LEGAL ELEMENTS: LEGAL ISSUES Investigations in Private Actions Defamation Invasion of Privacy False Imprisonment Malicious Prosecution Intentional and Negligent Infliction of Emotional Distress Wrongful Termination Employee Polygraph Protection Act of 1988 (29 U.S.C. 2001, et seq.) Rights and Duties of Employees Employees Duty to Cooperate Employees Rights During the Investigation Contractual Rights Whistleblower Protections Employees Constitutional Rights Electronic Communications Company Policy Regarding Searches Privacy of Financial Records Review Questions VII. FRAUDULENT FINANCIAL TRANSACTIONS: FRAUD SCHEMES Introduction Asset Misappropriation Schemes Cash Schemes Accounts Receivable Fraud Schemes Inventory Fraud Schemes Fixed Asset Schemes Fraud by Vendors Bid-Rigging and Market Division Schemes Overbilling Schemes Shell Companies Collusion Between Vendors and Employees Detection Corruption Methods of Making Illegal Payments Economic Extortion Conflict of Interest Review Questions iii

5 VIII. INVESTIGATION: SOURCES OF INFORMATION Introduction In-House Sources Public Records Local or County Records The Courts: Civil Actions or Criminal Actions State Records Newspapers, Journals, Periodicals, and Professional Papers Non-Public Records Banking Records Tax Returns and Related Documents Credit Records Telephone Records Credit Card Account Records Legal Concerns in Obtaining Records Fair Credit Reporting Act Business Information and Credit Reports Third-Party Proprietor Review Questions IX. FRAUDULENT FINANCIAL TRANSACTIONS: FINANCIAL STATEMENT FRAUD Introduction to Financial Statement Fraud Schemes Earnings Management and Manipulation Reasons for Manipulation Conditions Present for Manipulation How Organizations Manipulate Financial Results Red Flags of Manipulated Financial Results Reviewing Financial Statements for Manipulation Basic Steps Financial Statement Analysis Vertical Analysis Horizontal Analysis Ratios Review Questions X. INVESTIGATION: INTERVIEWING PROSPECTIVE WITNESSES Introduction Research Effective Questioning Content Form Timing Introductions, Physical Meeting, and Rapport Building Arrangements and Introductions Convenient Time and Place Venue iv

6 X. INVESTIGATION: INTERVIEWING PROSPECTIVE WITNESSES (CONT.) Seating Arrangement Small Talk Tell Me What Happened Recording an Interview Note-Taking Responses and Buried Leads Follow-Up Interviews Review Questions XI. LEGAL ELEMENTS: RULES OF EVIDENCE Definition of Evidence Three Basic Forms of Evidence Two Basic Types of Evidence Burden of Proof Admissibility of Evidence Relevance Character Evidence The Exclusionary Rule Admissibility of Real Evidence Authentication Chain of Custody Best Evidence Rule Admissibility of Testimonial Evidence Types of Witnesses Impeachment Hearsay Privileges Attorney-Client Privilege Attorney Work Product Doctrine Other Common Privileges Review Questions XII. INVESTIGATION: EVALUATING DECEPTION Physiology of Deception Norming or Calibrating Review Questions XIII. FRAUDULENT FINANCIAL TRANSACTIONS: ANALYZING AND MANAGING FINANCIAL INFORMATION Introduction Computer Analysis Analytical Software Commercial Data Analysis Programs Spreadsheets and Databases Customized Data Analysis Programs Shareware and Freeware Data Analysis Programs Using Analysis to Detect Illicit Income v

7 XIII. FRAUDULENT FINANCIAL TRANSACTIONS: ANALYZING AND MANAGING FINANCIAL INFORMATION (CONT.) Review Questions XIV. INVESTIGATION: ADMISSION-SEEKING INTERVIEWS Introduction Preparation Interview Room Presence of Outsiders Miranda Warnings National Labor Relations Act Steps in the Admission-Seeking Interview Develop a Theme for the Interview Direct Accusation Observe Reaction Repeat Accusation Interrupt Denials Establish Rationalization Diffuse Alibis Present an Alternative Question Obtain a Benchmark Admission Reinforce Rationalization Verbal Confession Specifics of Each Offense Review Questions XV. FRAUD PREVENTION AND DETERRENCE: PREVENTION OF FRAUD Deterrence Theory Prevention Versus Deterrence General Deterrence Specific Deterrence Punishment Formal Sanctions Informal Sanctions The Perception of Detection Employee Education Management Oversight Ensure Employees Are Aware That Dishonest Acts Will Be Punished Reporting Programs Minimize Employee Pressures Proactive Audit Policies Review Questions XVI. LEGAL ELEMENTS: TESTIFYING Introduction Direct Examination Key Points in Testifying Cross-Examination vi

8 XVI. LEGAL ELEMENTS: TESTIFYING (CONT.) Impeaching Fact Witnesses During Cross Examination Common Areas of Attack in Cross-Examination Summary The Ten Commandments of Testifying Review Questions XVII. INVESTIGATION: SIGNED STATEMENTS Introduction Voluntariness of Confession Intent Approximate Dates of Offense Approximate Amounts of Losses Approximate Number of Instances Willingness to Cooperate Excuse Clause Confessor Read Statement Truthfulness of Statement Key Points in Signed Statements Review Questions XVIII. INVESTIGATION: REPORT WRITING Introduction Purpose of the Report Conveys Evidence Adds Credibility Accomplishes Objectives of Case Know the Reader Format Summary Introduction Body Results Follow-Up/Recommendations Opinions or Conclusions in Report Discovery of Investigative Reports Review Questions XIX. FRAUD GLOSSARY XX. APPENDIX: VIDEO TRANSCRIPT XXI. SOLUTIONS TO REVIEW QUESTIONS XXII. FINAL EXAMINATION... E-1 XXIII. INDEX... I-1 vii