2013-11-19 Nonprofit Fraud Part 2

NONPROFIT FRAUD: WHAT
YOU NEED TO KNOW
PART II: THE DETECTION

Lawrence J. Hoffman, CPA/CFF, CVA, CFE
Senior Partner and Director of Forensic
Accounting Services
Leslie C. Kirsch, CFE
Manager, Forensic Accounting Services
November 19, 2013

OBJECTIVES
NONPROFIT FRAUD: THREE-PART SERIES
PART I: THE FRAUD
• Why it is important that you are educated in fraud
• The magnitude of fraud in nonprofits
• The types of frauds in nonprofits
• Why does fraud occur in nonprofits
• Some important fraud prevention takeaways

PART II: THE DETECTION
• Why do people commit fraud?
• How is fraud detected?
• Who are the fraud perpetrators?
• Fraud detection techniques
• What should you do when you uncover fraud?

PART III: THE PREVENTION
• Fraud risk assessments
• Setting the tone at the top and your board of directors
• What are the best preventative measures and controls?
• The five critical takeaways!
Part II: The Detection * Page 2

AGENDA
• Why do people commit fraud?
• How is fraud detected?

• Who are the perpetrators?
• Fraud detection techniques
• What should you do when you uncover a fraud?


WHY DO PEOPLE COMMIT FRAUD?
THREE REASONS WHY PEOPLE COMMIT CRIMES
• Economics  $$$$$
• Passion  love, lust, a cause (religious beliefs)
• Mental instability  nuts


THE FRAUD TRIANGLE
Pressure / Incentive (The
―Unshareable‖ Need)

Opportunity
(lack of controls)

Rationalization
(frame of mind or
ethical character)


THE FRAUD TRIANGLE
THE FRAUD TRIANGLE ORIGINATED FROM
DR. DONALD CRESSEY'S HYPOTHESIS:
“Trusted persons become trust violators when they conceive of
themselves as having a financial problem which 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 conduct 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.1 ‖

1DONALD

R. CRESSEY, OTHER PEOPLE'S MONEY
(MONTCLAIR: PATTERSON SMITH, 1973) P. 30.

THE FRAUD TRIANGLE
PRESSURE


PRESSURE / INCENTIVE
(THE NEED, PERCEIVED OR ACTUAL)
• Financial pressure and debts
• Greed – need for high lifestyle-living beyond their means
• Feed a habit – gambling, drugs, other addictive behaviors
• Retribution / vendetta – feels abused or exploited-holds a
grudge
• Make earnings target or financial metric (bonuses)
• Need for praise and gratification
• Competitive pressures – keep your job
• Medical issues of family or self


THE FRAUD TRIANGLE
OPPORTUNITY


OPPORTUNITY (PERCEIVED)
• Weak or non-existent internal controls – lack of segregation of
duties
• Has sufficient access to assets and information that enables
the crime
• Has assessed that that the fraud can be committed and also
successfully concealed
• Too much trust placed in person or position. (Remember: trust
is not an internal control!)
• Poor communication within organization
• Lack of oversight and supervision
• Lack of disciplinary action for previous frauds


THE FRAUD TRIANGLE
RATIONALIZATION


RATIONALIZATION (A WAY TO RATIONALIZE THE
BEHAVIOR AS ACCEPTABLE)
• ―I am just borrowing the money and will repay it‖
• ―I‘ll stop once I pay off my debts‖
• ―The company won‘t even realize this amount is gone; it‘s not
that much‖
• They feel they deserve it: ―I am getting underpaid and am
underappreciated‖
• ―Management is ‗living high,‘ while I am oppressed‖
• ―Everyone‘s doing it, I am no different‖
• ―It is for a good purpose‖
• They need the money


THE FRAUD TRIANGLE
WHEN ALL THE ELEMENTS COME TOGETHER


HOW IS FRAUD DETECTED?
• The detection of fraud involves the ability to recognize in a
timely manner whether fraud has occurred or is occurring
• However, a properly designed and executed audit may still
NOT detect material fraud, especially one involving:
– Forgery
– Deliberate failure to record transactions
– Intentional misrepresentations
– Collusion

• Ability to detect fraud depends on:
– Skillfulness of perpetrator
– Frequency and extent of manipulation
– Degree of collusion
– Relative size of individual amounts manipulated
– Seniority of individuals involved



2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE

KEY TAKEAWAY: ESTABLISH
POLICIES, PROCEDURES AND MECHANISMS
FOR TIPS!
•
•
•
•

Employees
Vendors
Customers
Other stakeholders


WHO ARE THE PERPETRATORS?
THE FACES OF FRAUD


TYPICAL PROFILE
• Usually living above their means or has an addictive need

• Does not have a prior criminal conviction or charged with a fraud
• Has a position of trust and responsibility
• Most likely a male between the age of 31 to 45
• Is well educated
• Understands and skillfully uses technology
• Usually comes across as a nice person, charming
• Usually well respected
• They usually spend everything they steal!
• 80% will buy a new car!


FRAUD PERPETRATORS ARE NOT CAREER CRIMINALS


FRAUD PERPETRATORS DO NOT HAVE A PRIOR HISTORY OF
BEING PUNISHED OR TERMINATED BY AN EMPLOYER FOR A
FRAUD-RELATED OFFENSE


FRAUD PERPETRATOR IS TYPICALLY AN EMPLOYEE OR
MANAGER


LARGER LOSSES WITH THE OWNER/EXECUTIVE


MALES TEND TO ACCOUNT FOR ABOUT TWO-THIRDS OF
ALL FRAUD CASES


TYPICALLY BETWEEN AGES 31 AND 45


AMOUNT OF LOSS ROSE WITH AGE!


LOSS WAS GREATER WITH TENURE OF PERPETRATOR


MORE THAN HALF HAD A COLLEGE DEGREE OR HIGHER!


ACCOUNTING DEPARTMENT TOPS THE LIST!


WHO DID THE FBI PROFILE WITH
THESE SYMPTOMS AND SIGNS?
• Anger and arrogance
• Capable of acting witty and charming
• Good at flattery and manipulating other people‘s emotions
• Disregards the safety of self and others
• Does not show any guilt
• Lies, steals, and fights often
• Breaks the law repeatedly
• Substance abuse and/or legal problems

―Provided a man is not mad, he can be cured
of every folly but vanity.‖
- Jean-Jacques Rousseau


BERNIE’S JAIL CELL


ANTISOCIAL PERSONALITY DISORDER (ASPD OR APD)
• A psychiatric condition in which a person
manipulates, exploits, or violates the rights of others
• Usually begins in childhood or early adolescence and
continues into adulthood
• ―Boomerang Personality‖-everything you throw at them, they
throw back at you. It is always the other person‘s fault. Will not
accept responsibility
• Person with no conscience
• Is usually criminal
• Also referred to as ―sociopaths‖ and ―psychopaths‖


SOCIOPATHS
• Are unable to experience emotional responses for other people
outside of their own personal interests
• Psychological inability to show emotion or caring for others
• While a sociopath can feel emotion, it is (even if it results in
care for another), because they find it viable for themselves as
opposed to what would be termed as selflessness


THE DILEMMA
• Everyone has to a degree a propensity to commit a crime!

• 93-95% of the population may commit a crime
• 5-7% are hard-core white collar criminals
• We are interested in the severity of the propensity of the 9395% and definitely don‘t want the 5-7% working for us!


THE SYNTONIC SYNDROME
Five key characteristics of the hard-core white collar
criminal (5-7%)
• Ego-syntonic: ―not my fault-ism‖, where they re-arrange
events to be continually interpreted in their favor, often at the
expense of another person (vs. ―ego-dystonic‖)
• Personality disorders: the person probably has a
psychological problem called a personality disorder
• High IQ: the person has a high IQ
• Differential treatment: the person treats different people
differently within organization, usually based on who can give
them what they want. Bottom line: people are carefully
manipulated
• Controls decisions: the person seeks to control – or create –
the (decision-making) process, especially in areas where they
can personally benefit

FRAUD DETECTION TECHNIQUES
RED FLAGS
BEHAVIOR FLAGS
•
•
•
•
•
•
•
•
•
•
•

Financial difficulties
Living beyond means relative to known income level
Family problems
Serious addiction to drugs, alcohol, or gambling
An unwillingness to share duties or allow others to help
Defensive behavior-overly nervous when questioned
A refusal to take vacations or very short vacations
Over-devotion to the job-working a lot of overtime and
weekends-never calls in sick or misses work!
A close personal relationship with vendors or customers
Change in behavior
Rule breakers


LIVING BEYOND MEANS #1!



LIVING BEYOND MEANS FUELED BY ASSET MISAPPROPRIATION!


FINANCIAL AND BUSINESS FLAGS
•
•
•
•
•
•
•

•
•
•

Business is inexplicably unprofitable
Company is having cash flow problems
Under capitalized
Financial statements are always late
Financial statement trends/ratios are inconsistent and do not
make sense
Financial records and books are in disarray and always out of
balance
Management‘s operating and financial decisions are
dominated by a single person or a few persons acting in
concert
Background checks are not conducted on key employees
High turnover of management and/or key accounting personnel
Management displays a propensity to take undue risks


FINANCIAL AND BUSINESS FLAGS (continued)
•
•
•
•
•
•
•
•
•
•

Accounting personnel exhibit inexperience or laxity in
performing their duties
Numerous banks and accounts
Frequent change in independent auditors/accounting firm
Management places undue pressures on the auditors, through
fees and unreasonable deadlines
Frequent legal matters
Frequent change in legal counsel and multiple law firms
Operates on a ―crisis‖ basis
Fire people quickly if they don‘t do what they want
Significant transactions with related parties
Problems with governmental and regulatory agencies


INTERNAL CONTROL FLAGS
•

•
•
•
•
•
•
•

•

A single employee controls the company finances and
accounting-lack of segregation of duties!
Bank accounts are not timely reconciled and not reviewed by
someone independent of preparer
Invoices are paid without verifying receipt or purchase
authorizations
Reimbursements are not supported by receipts or other
supporting documentation
Excessive sales voids and credit memos
Missing deposit slips and/or cancelled checks
Unexplained inventory shortages or adjustments
Subsidiary account balances not reconciled
Unexplained and numerous end-of-period adjusting entries


INTERNAL CONTROL FLAGS (continued)
•
•
•

Missing documents
Altered documents
Photocopy of documents when originals should be available



PREVENTIVE VS. DETECTIVE
CONTROLS


PREVENTIVE CONTROLS
Preventive controls attempt to deter or prevent undesirable
events from occurring. They are proactive controls that help
prevent a loss.

DETECTIVE CONTROLS
Detective controls, on the other hand, attempt to detect
undesirable acts. The provide evidence that a loss has occurred
but do not prevent a loss from occurring.
Detective techniques should be used to uncover fraud events
when preventive measures fail or unmitigated risks are realized.


PREVENTIVE AND DETECTIVE CONTROLS IN ACTION


PREVENTIVE CONTROLS
• Segregations of duties with well defined job descriptions and
policies and procedures
• Job rotation
• Mandatory vacations
• Obtaining pre-approval on transactions before processing
• Require dual signatures on checks above a certain amount
• Using document control numbers to account for all
transactions-checks, purchase orders, invoices etc…
• Matching and comparing documents
• Testing clerical accuracy
• Physical controls over cash, checks, signatures, inventory and
other assets
• Computer passwords and access controls to prevent
unauthorized electronic access

PREVENTIVE CONTROLS (CONTINUED)
• Back up financial files daily
• Pre-employment background investigations
• Employee training programs-fraud prevention
• Prosecute the guilty


DETECTIVE CONTROLS
• Whistleblower Policies and Hotlines (TIPS!!!)
• Management and supervisory reviews and approvals
• Reconciliations
• Independent review of bank reconciliations and supporting
documents-cancelled checks
• Independent review of vendor control file for suspicious
vendors
• Independent review of payroll files for suspicious employees.
• Investigate customer and vendor complaints promptly
• Physical inspections/counts
• Financial analysis, budget vs. actual
• Data analysis, data mining and continuous auditing techniques
• Other technology tools
• Audits-external, internal, surprise

WHAT SHOULD YOU DO WHEN YOU
UNCOVER FRAUD?
• BE AWARE OF WARNING SIGNS
• REPORT IRREGULARITIES, SPECIFICALLY:
– If someone you work with asks you to do something that is
illegal or unethical
– If you suspect that someone— regardless of rank or
position—is committing fraud or abuse


UNCOVER FRAUD?
• Follow your organizations fraud policy
• Report through hotline or other anonymous reporting
mechanism
• Anonymous letter to company official
• Share your concern with your immediate supervisor or
organization‘s audit committee
• Do not confront the suspected perpetrator

• Do not investigate the matter on your own


UNCOVER FRAUD?
• Organization management should retain counselattorney/client privilege
• Employers have a duty to investigate promptly and thoroughly

• Counsel should retain a forensic expert to assist in the
investigation
• Employee (suspect) may be suspended with or without paybut do it swiftly if enough predication is present
• Employee (suspect) access to offices, computer
systems, banking, communications and other access rights
and privileges should be suspended or terminated
• Preserve evidence
• Understand legal implications

• Inform your insurance carriers


UNCOVER FRAUD?
• Objectives of the investigation should be conducted with
integrity, fairness, impartiality and respect and include:
– Gathering the facts

– Determining the merits of the complaint
– Complying with legal obligations
– Maintaining confidentiality
– Preserving the reputations of individuals and the
organization
– Taking proper remedial action
– Avoiding liability
– Preventing future claims and incidences


UNCOVER FRAUD?
• Everyone in an organization is responsible for fighting fraud.
• Be alert to potential fraud.
• Report any suspicions to your organization


WHAT YOU NEED TO KNOW ABOUT FRAUD
THE FIVE MOST IMPORTANT TAKEAWAYS – AGAIN!
1. Trust is not an internal control!
– Establish, to the extent possible, controls and procedures that eliminate the
element of trust
– Always segregate the custody of the asset with the recordkeeping for the asset

2. Set the tone from the top!
– ―If you are stealing, your employees are stealing!‖
– E.g., office supplies, expense reports, etc.

3. Know your employees!
– Background investigations and public records checks before hiring
– Meet and establish a baseline relationship

4. Institute a fraud policy
– No tolerance
– Will prosecute

5. Establish a hotline for tips
– Number one method for detecting fraud!
– Can outsource

MY BOOK!
EXPECTED RELEASE
THIS WINTER!
STAY TUNED!


HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?

A resource for the nonprofit community to help
organizations effectively manage risk and better ensure the
prevention and detection of fraud.

Check us out at WWW.RAFFA.COM/FRAUD


HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
FRAUD INVESTIGATIONS AND PREVENTION
• Fraud examinations and internal investigations
• Review of internal controls and management practices
• Financial statement misrepresentations
• Background and workplace investigations
• Computer forensic analysis, imaging, data mining and recovery
• Asset tracing and recovery
• Reconstruction of accounting records
• Continuous audit services
• Anti-fraud consulting and training

SOME AREAS WE WILL BE GOING OVER IN
OUR OTHER PRESENTATION
PART III: THE PREVENTION –
DECEMBER 12, 2013, 12:00-2:00 P.M.
• Setting the tone at the top and your board of directors
• What are the best preventative measures and controls?
• The five critical takeaways!


RESOURCES AND SUGGESTED READING
• 2012 Report to the Nations on Occupational Fraud and
Abuse, Association of Certified Fraud
Examiners, http://www.acfe.com/rttn.aspx

• “The American Fraud Report,” http://www.jpsimsconsulting.com
• The CPA’s Handbook of Fraud and Commercial Crime
Prevention, AICPA
• Managing the Business Risk of Fraud: A Practical Guide;
AICPA, ITA, and ACFE; https://na.theiia.org/standardsguidance/Public%20Documents/fraud%20paper.pdf


QUESTIONS AND ANSWERS


BIOGRAPHY
•
•

Started career with a Big-Four international accounting firm in Washington, DC.

•

Founded a regional certified public accounting and consulting firm in 1982 and grew it to
on of the Washington, DC‘s largest firms in seven years. Merged his practice with Raffa
P.C. in 2008.

•

Managed and conducted audit and accounting engagements ranging from small privately
held to large publicly held businesses in various industries, including multi-national
businesses, nonprofit organizations, and governmental entities and agencies.

•

Performed economic and financial analysis, including projections and forecasts, in support
of litigation and claims for lost earnings and profits, business interruption, shareholder
disputes, patent and trademark infringements, bankruptcy and restructuring, and structural
settlements; assistance with interrogatories, document requests and depositions; and
serving as an expert and consulting witness.

•

LAWRENCE J.
HOFFMAN, CPA/CFF, CVA,
CFE

35 years of consulting, audit, accounting and tax experience in the public and private
sectors.

Performed and supervised business valuations for both public and closely held companies
in a variety of industries, individuals and estates, family limited partnerships and limited
liability companies, including valuations for business combinations (SFAS 141R), mergers,
acquisitions, and divestitures, estate and gift taxes, marital dissolution proceedings, buysell agreements, intangible assets and intellectual property, purchase price allocations,
goodwill (SFAS 142) and long-lived asset (SFAS 144) impairment, fair value accounting
(SFAS 157), cheap stock (IRC 409A), stock-based compensation (SFAS 123R), phantom
stock and employee stock ownership plans.

•

Conducted and led teams of forensic accountants on fraud audits and investigations,
including fraudulent financial statements, misappropriations of assets and embezzlements;
money laundering, kickbacks, bribery and conflicts of interest; insurance claims;
bankruptcy; financial institutions and loan fraud.
Also has conducted fraud risk
assessments, anti-fraud programs, and fraud training and education.

SENIOR PARTNER
RAFFA, P.C.
1899 L STREET, NW
WASHINGTON, DC 20036
TEL. 202-822-5408
FAX 202-822-0669
LHOFFMAN@RAFFA.COM


BIOGRAPHY
•

•

Formulated strategic short- and long-term business and financial planning for various
business organizations and served as interim ―C‖ level positions, including for a major
North American sports league, European and U.S. aircraft manufacturer, aviation charter
airline and travel company, and a multi-chain quick service food chain.

•

Formulated syndication strategies and prepared business plans and private placement
offerings, including financial forecasts, market research and analysis, due diligence,
securities pricing and structuring for various public and private securities offerings,
including SEC filing.

•

Founded and developed a regional NASD licensed broker dealer investment banking firm.
Placed over $150 million in debt and equity and represented over $200 million in merger
and acquisition transactions.

•

LAWRENCE J.
CFE

Assisted companies and nonprofits with restructuring and turnaround situations, including
recapitalizations, reorganizations and liquidations. Advised entities on Chapters 11 and 7,
bankruptcy filings and proceedings and non-judicial workouts. Developed and
administered crisis management plans, cash flows, liquidation and turnaround analysis,
debt restructuring and creditor negotiations, and turnaround plans.

Founded and developed two private equity funds in excess of $10 million, including
investments in early stage and mature emerging companies in the form of debt and equity.
Portfolio investments included aviation, food and hospitality, software and technology,
telecommunications, sports and entertainment, banking and financial institutions,
healthcare, and wholesale and retail.

•

Co-founded and managed various real estate acquisition, ownership, and operating
entities, including commercial office buildings, shopping centers, flex warehouses,
residential housing and developed land.

•

Performed tax and financial consulting services for individuals and closely held
businesses.

•

Instructor in audit, accounting, finance, and forensic accounting.

SENIOR PARTNER


BIOGRAPHY
EDUCATION & CERTIFICATIONS

LAWRENCE J.
CFE

•
•
•

Bachelor of Science, Accounting – Mount St. Mary‘s University
Certified Public Accountant (CPA)
Certified Fraud Examiner (CFE)

•

Certified in Financial Forensics (CFF)

•
•
•
•
•

Certified Valuation Analyst (CVA)
Private Investigator (PI), Virginia
Series 7 General Securities Representative (not active)
Series 24 General Securities Principal (not active)
Series 63 Uniform Securities Agent (not active)

PROFESSIONAL ASSOCIATIONS & AFFILIATIONS
•

SENIOR PARTNER

American Institute of Certified Public Accountants, Member

•
•
•
•

Virginia Society of Certified Public Accountants
Association of Certified Fraud Examiners
National Association of Certified Valuation Analysts
Institute of Business Appraisers

PERSONAL INTERESTS
•
•
•

Private pilot with instrument, multi-engine, high performance complex and aircraft ratings
Golf and fishing
Reading and politics


BIOGRAPHY

Leslie C Kirsch, CFE

Manager
RAFFA, P.C.
1899 L STREET, NW
WASHINGTON, DC 20036

TEL. 202-955-7204
FAX 202-822-0669
LKIRSCH@RAFFA.COM

• 9 years of fraud investigation and financial audit experience
• Started career with U.S. Government Accountability Office‘s Forensic Audits and
Special Investigations Unit
• Led as many as 3 concurrent forensic audits and investigations on a variety of
topics, including: Federal contractor/grantee eligibility fraud and integrity issues;
federal tax collection program integrity; abuse of government purchase cards,
travel cards, and premium class travel privileges; employment of sex offenders
and child abusers at schools and child care facilities; passport application fraud;
manufacture and marketing of herbal dietary supplements
• Planned, developed, and completed audit and investigative objectives, scope,
and methodology
• Designed innovative analytical strategies and investigative techniques to identify
fraud indicators in complex datasets, using software packages such as IDEA and
SAS
• Identified, investigated, and ultimately referred hundreds of cases of potential
fraud, waste, and abuse to federal authorities for administrative action
• Led multiple undercover operations of varying complexity and political sensitivity
• Drafted numerous congressional testimonies and publicly available audit reports
(see co-authorship experience below)
• Designed and implemented internal quality assurance policies and procedures
• Bachelor of Science, Accounting – University of Maryland, College Park
• Bachelor of Science, Finance – University of Maryland, College Park
• Designated as a Certified Fraud Examiner (CFE) by the Association of Certified
Fraud Examiners

THE FRAUD TRIANGLE
PRESSURE


PREVENTATIVE CONTROLS


THE FRAUD TRIANGLE
RATIONALIZATION


THANK YOU!

Lawrence J. Hoffman – Senior Partner
Director of Forensic Accounting Services
lhoffman@raffa.com
202-822-5408
Leslie C. Kirsch – Manager, Forensic Accounting Services
lkirsch@raffa.com
202-955-7204

THANK
YOU!

2013-11-19 Nonprofit Fraud Part 2

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