Fraud Examination, 3E
Chapter 1: The Nature of Fraud
COPYRIGHT © 2009 South-Western, a part of Cengage Learning.
Learning Objectives
• Recognize the seriousness and effects of
fraud
• Define fraud
• Classify types of fraud
• Distinguish between criminal and civil
fraud laws
• Identify fraud-fighting careers
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The Seriousness of Fraud
Government Agencies
Fraud Victims Researchers
Sources of Fraud Statistics
Association of Certified
Insurance Companies
Fraud Examiners (ACFE)
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The Seriousness of Fraud
• U.S. organizations lose five percent of
annual revenues to fraud
• Applied to the estimated 2006 U.S. GDP,
this five percent translates to
approximately $652 billion in losses
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The Seriousness of Fraud
Fraud reduces a firm’s net income on a
dollar-for-dollar basis
FRAUD NET INCOME
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The Definition of Fraud
General Definition
a deception made for personal gain
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The Definition of Fraud
Seven Specific Parts of Fraud
A representation…
about a material point…
which is false…
and intentionally or recklessly so…
which is believed…
and acted upon by the victim…
to the victim’s damage.
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The Definition of Fraud
Fraud is… Fraud is not…
• intentional. • taken by physical
• to trick or deceive force.
someone out of • a mistake or error.
his/her assets. • victimless.
• theft. • insignificant
• a crime. because no one is
hurt.
• acceptable or
justifiable.
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The Various Classifications of Fraud
The Two General Classifications
– Committed against an organization
– Committed on behalf of an organization
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The Various Classifications of Fraud
Occupational Fraud
• Occupational fraud is the use of one’s
occupation for personnel enrichment
through the deliberate misuse or
misapplication of the employing
organization’s resources or assets.
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The Various Classifications of Fraud
With occupational fraud, the activity…
– is clandestine
– violates the employee’s obligations to the
organization
– is for direct or indirect financial benefit
– costs the organization assets, revenues, or
reserves
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The Various Classifications of Fraud
Classifications of Occupational Fraud
Asset Misappropriations
Corruption
Fraudulent Statements
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The Various Classifications of Fraud
Fraud classification according to victims:
– Company or Organization as victim
• Employee embezzlement
• Vendor fraud
• Customer fraud
– Shareholders as victims
• Management fraud
– Unwary individuals as victims
• Investment and other consumer fraud
– Anyone as a victim
• Miscellaneous fraud
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The Various Classifications of Fraud
Employee Embezzlement
– Occupational fraud (most common)
– Employees steal company assets
– Is direct or indirect
• Direct: employee directly steals company cash,
inventory, tools, supplies, or other assets
• Indirect: employee takes bribes or kickbacks from
vendors, customers, or others for lower sales
prices, higher purchase prices, nondelivery of
goods, or the delivery of inferior goods
– Example: Liahona Construction
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The Various Classifications of Fraud
Vendor Fraud
– Two main varieties:
• through vendors alone
• through collusion between buyers and vendors
– Usually results in:
• overcharge for purchased goods
• shipment of inferior goods
• Non-shipment of purchased goods
– Example: Halliburton
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The Various Classifications of Fraud
Customer Fraud
– Where customers
• do not pay for goods
• get something for nothing
• deceive organizations into giving them something
they should not have
– Example: Chicago bank
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The Various Classifications of Fraud
Management Fraud
– Also known as financial statement fraud
– top management deceptively misstates
financial statements
– Examples:
• Enron
• WorldCom
• John Blue and his CFO
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The Various Classifications of Fraud
Investment and Other Consumer Fraud
– Worthless investments sold to investors
– Examples:
– Ponzi schemes
– Senior investment fraud
– Promissory notes
– Unscrupulous stockbrokers
– Affinity fraud
– Unlicensed individuals, such as independent insurance
agents, selling securities
– “Prime bank” schemes
– Internet fraud
– Mutual fund business practices
– Variable annuities
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The Various Classifications of Fraud
Type of Fraud Victim Perpetrator Explanation
Employee Employees directly or
Employers Employees
Embezzlement indirectly steal from employers
Stockholders,
Top management‘s
lenders, & others Top
Management misrepresentation of financial
relying on financial management
information
statements
Individuals trick investors into
Investment Scams Investors Individuals putting money into fraudulent
investments
Organizations /
Organizations that Overcharged for goods &
individuals
Vendor buy goods & services or non-shipment of
selling goods &
services goods paid for
services
Customers deceive sellers into
Organizations selling
Customer Customers giving them something they
goods and services
19 should not have
Criminal and Civil Fraud Laws
Law
Criminal Law Civil Law
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Criminal and Civil Fraud Laws
Criminal Law Case Civil Law Case
Purpose To right a wrong To obtain a remedy
Consequences Jail and/or fines Restitution & damage payments
Burden of Proof “Beyond a reasonable doubt” “Preponderance of evidence”
Jury Must have 12 people May be fewer than 12 persons
Determination by a grand jury that
Organization Filing of a claim by a plaintiff
sufficient evidence exists to indict
Parties may stipulate to a less than
Verdict Unanimous verdict
unanimous verdict
Various claims my be joined in one
Claims Only one claim at a time
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Fraud-fighting Careers
Type of Career Types of Employers and Career Description
FBI, postal inspectors, Criminal Investigation Division of the
IRS, U.S. marshals, inspector generals of various
Government and law enforcement
governmental agencies, state investigators, and local law
enforcement officials.
Conduct investigations, support firms in litigation, do
CPA firms bankruptcy-related accounting work, provide internal audit
and internal control consulting work.
Prevent, detect, and investigate fraud within a company.
Corporations Includes internal auditors, corporate security officers, and
in-house legal counsels.
Serve as an independent consultant in litigation fraud
Consulting work, serve as expert witness, consult in fraud prevention
and detection, and provide other fee-based work.
Lawyers provide litigation and defense work for companies
Law firms and individuals being sued for fraud and provide special
22 investigation services when fraud is suspected.
Prepare for a Fraud-fighting Career
Skills for Fraud-fighting Professionals
– Analytical Skills
• examine data for symptoms of fraud
– Communication Skills
• effectively interview witnesses and suspects
• communicate findings to witnesses, courts and
others
– Technology Skills
• search for fraud by effectively using information
systems
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Prepare for a Fraud-fighting Career
More Skills for a Fraud-fighting Professional
– Some understanding of accounting and
business
– A knowledge of civil and criminal laws,
criminology, privacy issues, employee rights,
fraud statutes, and other legal fraud-related
issues
– The ability to speak and write in a foreign
language
– A knowledge of human behavior
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Become a Certified Fraud Examiner
• Be an associate member of the ACFE in
good standing
• Meet minimum academic and professional
requirements:
– Bachelors Degree
– Two years of professional experience directly
or indirectly related to fraud examination
• Be of high moral character
• Agree to abide by the Bylaws and Code of
Professional Ethics of the ACFE
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