CHAPTER 3

Question 2

Fraud Examination, 7E
Chapter 3: Fighting Fraud: An Overview

Question 3

W. Steve Albrecht | Chad O. Albrecht | Conan C. Albrecht | Zimbelman, Fraud Examination, 7th Edition. © 2025 Cengage. All
Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1

Question 4

Learning Objectives (1 of 2)

Question 5

After studying this chapter, you should be able to:
• Recognize the different ways in which organizations fight fraud.
• Understand the importance of fraud protection.
• Understand how to create a culture of honesty and high ethics.
• Under why hiring the right kind of employees can greatly reduce the risk of fraud.

Question 6

Learning Objectives (2 of 2)

Question 7

After studying this chapter, you should be able to:
• Understand how to assess and mitigate the risk of fraud.
• Understand the importance of early fraud detection.
• Understand the different approaches to fraud investigation.
• Identify the different options for legal action that can be taken once fraud has occurred.

Question 8

Fraud Fighting Overview

Question 10

Need For Comprehensive Fraud Program

Question 11

• There is no such thing as a small fraud – only large frauds that are caught early.
• Four elements of an effective fraud fighting program:
1) Fraud prevention
2) Early fraud detection
3) Fraud investigation
4) Follow-up legal action and resolution
• Elements 3) and 4) are the costliest and least effective

Question 12

Fraud Prevention

Question 13

• Most cost-effective way to reduce losses from fraud.
− Avoids embarrassment to both victim and perpetrator
− Eliminates the need for legal action and stolen proceeds repayment
− Less expensive than fraud investigation
• Fraud cannot be completely prevented, but its frequency can be reduced.
− Create and maintain a culture of honesty and high ethics.
− Assess fraud risks and develop concrete responses to reduce fraud risk and opportunity.

Question 14

Five Elements of a Culture of Honesty and High Ethics
1) Making sure that top management models appropriate behavior
2) Hiring the right kind of employees
3) Communicating the right expectations throughout the organization and requiring periodic written confirmation of expectation acceptance
4)Creating a positive work environment
5) Developing and maintaining an effective policy for fraud when it occurs

Question 15

Tone at the Top: Management Behavior

Question 16

• Management cannot act one way and expect subordinates to behave differently.
− Managers must demonstrate through their own actions that dishonest, questionable, and unethical is not tolerated.
• Media is full of prominent upper management modeling dishonest behavior.
− Bad modeling by upper management cannot be hidden from employees or the pubic.
• Employees rationalize that if fraud is okay for the leaders, it is okay form them.

Question 17

Hiring the Right Kind of Employees

Question 18

• Effective hiring practices must distinguish between marginally ethical and highly ethical individuals.
− Especially true for high-risk positions
• Proactive hiring practices for hiring ethical individuals:
− Conduct background checks
− Check references
− Properly interpret responses to inquiries regarding candidates
− Testing for honesty and other attributes

Question 19

Ethical Maturity Model (EMM)

Question 20

Figure 3.1: Ethics Development Model

Question 22

Challenges to Ethical Decision Making

Question 23

• The translation of personal ethics (EMM level one) to business or financial settings (EMM level two) is difficult for many people.
− Someone could have strong ethics in family or social matters, but not understand that dishonest accounting is unethical.
− Most people engaged in questionable financial actions consider themselves to be honest, ethical people.
• Few individuals have the courage to stand up for ethical beliefs when personal consequences for doing so are perceived as high.

Question 24

Distribution of Employee Honesty

Question 25

• In most organizations, employees fall into three groups regarding honesty: − Group #1: honest regardless of circumstances − Group #2: dishonest whenever it benefits them − Group #3: honest depending on their situation and environment • Group #3 (swing group) represents the majority of employees. − Highly influenced by organizational structure and culture − Likely to be honest when companies have strong ethical leadership

Question 26

Distribution of Employee Honesty (2 of 2)

Question 27

Figure 3.2: Honesty of Employees

Question 29

Knowledge Check #1 Debrief 1) Expedite termination for fraud perpetrators.  Incorrect: Fraud perpetrators should be prosecuted because this sends a message intolerance of fraud to other employees. 2) Create a department to confidentially investigate suspected fraud.  Incorrect: Fraud investigation is costlier and less effective than fraud prevention. 3) Institute a company-wide ethics awareness program including both expectations and consequences.  Correct: Fraud prevention through creation of a culture of honesty is the most cost-effective of fraud prevention activities.

Question 31

Three Steps to Communicate Expectations of Honesty and Integrity 1) Identify and codify appropriate values and ethics. 2) Institute fraud awareness training that helps employees understand potential fraud problems and how to report or resolve them. 3) Communicate consistent expectations about punishment of violators.

Question 32

Ethics Communication Tools

Question 33

• Published codes of conduct, posters, and videos presented at hiring and regular training intervals • Periodic, written employee confirmation that they understand ethics expectations. • Clear statements from management regarding consequences of dishonesty, including termination and prosecution • Codes of conduct conveying expectations of appropriate behavior are required by law under the Sarbanes-Oxley Act of 2002 − Resource: Red Hat, Inc. open source business software’s code of conduct (reproduced in textbook’s Appendix A).

Question 34

Creating a Positive Work Environment

Question 35

• Fraud occurs less frequently when employees have positive feelings about their organization. • Factors that detract from a positive work environment:

Question 36

1. Top management that does not care 5. Low organizational loyalty or pay attention to employee behavior 6. Unreasonable budget expectations 2. Negative feedback and lack or 7. Unrealistically low pay recognition for job performance 3. Perceived inequities in an 8. Poor training and promotion organization opportunities 4. Autocratic rather than 9. High turnover and/or absenteeism participative management

Question 37

Proper Handling of Fraud and Fraud Perpetrators • No matter how good fraud prevention activities are, some fraud will probably still occur. • An organization’s reaction to fraud sends a strong signal that affects the number of future fraud incidents. − Thoroughly investigate facts. − Take firm and consistent actions against perpetrators. − Assess and improve fraud controls. − Provide communication and training to prevent future fraud.

Question 38

Assessing and Mitigating Fraud Risk (1 of 2)

Question 39

• How organizations can proactively eliminate fraud opportunities: 1) Accurately identify sources and measure risks 2) Implement appropriate preventative and detective controls to mitigate those risks 3) Create widespread monitoring by employees 4) Retain both internal and external auditors who provide independent checks on performance

Question 40

Assessing and Mitigating Fraud Risk (2 of 2)

Question 41

• Define where the greatest fraud risks are: − Consider organizational, industry, and geographic-specific characteristics that influence fraud. • Evaluate and test controls that mitigate those risks: − Where is fraud most likely to occur in our organization? − Which employees are in the best position to commit fraud against our company? − If fraud occurred, what kinds of symptoms would they generate?

Question 42

Sarbanes-Oxley Act of 2002

Question 43

• Recognizes the value of having a system for employees and others to report wrongdoing. • Sarbanes-Oxley section 806 and 18 U.S.C. 1513(e) requires every public company to do the following: − Have a whistleblower system − Prohibit retaliation against an employee who uses it • Legislation prompted by the chain of events that resulted in the 2001 Enron scandal

Question 44

Fraud Detection (1 of 2)

Question 45

• Most fraud perpetrators start by stealing small amounts. − They steal larger amounts as they become confident that they will not be caught. • If fraud perpetrators are in upper management, they are less likely to be caught and may start by stealing relatively large amounts. • Fraud detection includes actions taken to discover fraud. − Detection does not include investigation or legal actions. − Begins by identifying symptoms (red flags) that tend to be associated with fraud

Question 46

Fraud Detection (2 of 2)

Question 47

• Primary ways fraud can be detected: − Chance − Providing ways for people to report fraud suspicions − Proactively examining transaction records and documents • In the past, most fraud was detected by accident, allowing plenty of time for large amounts of money or property to be stolen. • Individuals in victim organizations reluctant to report suspicious activity − Not sure fraud was occurring or afraid of consequences for becoming a whistleblower

Question 48

Proactive Fraud Detection (1 of 2)

Question 49

• Install a fraud-reporting hot line (whistleblowing system) − Employees can report fraud anonymously without fear of retribution. • Fraud reporting services can be provided in-house or outsourced to independent organizations. − Association of Certified Fraud Examiners and Navex Global • Fraud-reporting hotlines are subject to abuse: − Reporting hoaxes − Grudge or anger-motivated reporting

Question 50

Proactive Fraud Detection (2 of 2)

Question 51

• Analyze data and look for indicators of fraud – “red flags” − Suspicious trends − Frequent occurrences − Unexpected numbers • Fraud analysis algorithms can be applied to databases to proactively look for fraud symptoms. − Detection algorithms can be tailored to the business and data type. − Banking fraud schemes, such as kiting, are easy to spot with automated data analysis.

Question 52

Fraud Investigation

Question 53

• Detection of potentially fraudulent behavior (“red flag”) creates a “predication of fraud”. − Predication is a prerequisite for fraud investigation. • Once predication is present, fraud investigation is used to determine: − Whether fraud actually occurred − The who-what-when-where elements of the fraud • Fraud investigation is expensive, sensitive, and complex. − Must avoid injuring the reputations of innocent parties or letting guilty parties go undetected

Question 54

Approaches to Fraud Investigation

Question 55

• Investigation must be done with approval from the organization’s management. • The fraud investigation must not be detectable to perpetrators: − They might hide or destroy evidence in order. − They might commit suicide in order to avoid humiliation. • Remember that most fraud perpetrators are first-time offenders and the though of being caught is traumatic.

Question 56

Four Types of Fraud Investigation Evidence

Question 57

• Testimonial: gathered from individuals via interviews and honesty tests • Documentary: gather from paper, computers, or other written sources − Effective tools include data mining, public records searches, audits, net worth calculations, and financial statement analysis • Physical: fingerprints, tire marks, weapons, stolen property, identification numbers, and other tangible evidence. − Usually gathered via forensic analysis by experts • Personal: acquired by the investigators themselves by invigilation, surveillance, covert operations

Question 58

Evidence Square for Fraud Investigation

Question 59

Figure 3.3: Evidence Square

Question 61

Fraud Elements and Motivation Triangles (1 of 2) • Investigate based on the likely motivations for fraud: − Perceived pressure − Perceived opportunity − Rationalization • Investigate based on the necessary elements of fraud: − Theft act − Concealment − Conversion

Question 63

Fraud Elements and Motivation Triangles (2 of 2)

Question 64

Figure 3.4: Elements of Fraud

Question 66

Steps for Conducting a Fraud Investigation (1 of 2) 1) Actions must be taken only to “establish the truth of the matter under question.” 2) Individuals conducting the investigation must be experienced, objective, and avoid jumping to conclusions. 3) Hypotheses of investigators regarding culpability must be closely guarded when discussing the progress of the investigation. 4) Ensure that only those who have a need to know are kept apprised of investigation activities and techniques.

Question 67

Steps for Conducting a Fraud Investigation (2 of 2) 5) Ensure that all information gathered during the investigation is independently corroborated and factually correct. 6) Investigators should restrict investigation techniques to those that are scientifically and legally sound and fair. 7) Investigators should report all facts fairly and objectively.

Question 68

Follow-Up Legal Action

Question 69

• Most organizations and fraud victims make one of three choices regarding legal action against the perpetrator: − Pursue no legal action − Pursue civil remedies − Pursue criminal action (sometimes done by law enforcement) • Victim organizations pursue legal action against perpetrators in less than half of fraud cases. − Sends a message to future fraud perpetrators that “nothing serious will happen if you steal from this company.”

Question 70

Civil Action

Question 71

• Unless fraud perpetrators have considerable assets, civil action is rare in employee fraud. • Civil actions are more common with fraud against individuals or when perpetrators are perceived as having “deep pockets.” • Vendors who provide kickbacks for often the target of civil action by victim companies. • Stockholders and creditors victims of financial statement fraud usually sue perpetrators and anyone associated with the company perceived to have “deep pockets.” − Frequently result in class-action lawsuits

Question 72

Criminal Action

Question 73

• Can only be brought by law enforcement or statutory agencies. • Victim organizations wishing to pursue criminal action must work with local, state, and federal agencies to prosecute fraud perpetrators. • Criminal penalties may include restitution to victim organizations as well as fines and prison terms. • A criminal conviction is more difficult to obtain than a civil judgment. − Must have proof “beyond reasonable doubt”

Question 74

Summary

Question 75

Click the link to review the objectives for the presentation. Link to Objectives