Rosetti Fraud Strategy

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The Importance of a Fraud &

Misconduct Strategy

NYSICA

March 25, 2004

Presented by:

Christopher J. Rosetti, Partner

BST Advisors, LLC

Forensic Accounting and Investigative Services



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AGENDA:

Introduction

Tone at the Top

Code of Conduct Effective Fraud and Misconduct

Strategy

Best Practices Grant Administration



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Unknown:

´Confidence and trust are like amortal·s need for air. When therequired good is present, it·s nevernoticed. When it·s missing, it·s all that·s

noticedµ



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Public Misconduct

XYZ Agency Fails to Curb Fraud



Audit Risks for thePublic Sector



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The Principal Types

of Fraud

Bribery Conflicts of Interest

Theft of Money or Property

Breach of Fiduciary Duty



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Bribery

Giving or receiving a thing of value toinfluence a business decision without the

consent or knowledge of the principal.



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Conflicts of Interest

An agent taking an interest in a

transaction that is actually or potentiallyadverse to the principal without full andtimely disclosure to the principal



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Theft of Money or Property

EmbezzlementThe defendant took or converted, without theknowledge or consent of the organization, money

or property of another that was properlyentrusted to the defendant.

LarcenyTaking and carrying away money or property of

another, without the consent of the owner, withthe intent to permanently deprive the owner of itsuse or possession.



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Breach of FiduciaryDuty The principal fiduciary duties are loyalty and care.

Duty of Loyalty requires that the employee actsolely in the best interest of the employer, free of

any self dealing, conflicts of interest, or other abusefor personal advantage.

Duty of Care requires that persons in a fiduciaryrelationship must conduct business affairs

prudently with the skill and attention normallyexercised by a person in similar positions.



Many technological advances reduce the

audit trail and facilitate perpetration ofsophisticated computer crimes which

siphon funds to fictitious or unauthorizedaccounts.



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Internal Control Facts

Internal control starts with a strong controlenvironment:

� Management has the proper attitude andoperating style

� Management is the owner of internal control

� Internal controls are built into the business

process

Adapted from the 12/03 issue of Financial & Audit Solutions



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Is there an ethics/compliance program in place?

Has it been designed to satisfy leading governmental models (e.g., federal sentencing guidelines)?

Has it been implemented throughout theorganization, are there indicators that it isoperating as intended (e.g., frequency oftraining, volume of hotline calls, consistency of

discipline)?Has it been effective in achieving compliance

with the organization·s ethical and legalobligations?

Tone at the Top



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Fraud and

misconduct

reporting and response

Strong corporate culture,

values & ethics

Effective

Compliance Program

Fraud\misconduct

awareness

Effective personnel

policies

An Effective Fraud and

Misconduct Strategy



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Misconduct Strategy (continued)

Strong Corporate Culture with supporting

Ethics and Values

Credible leadership commitment

Corporate Values Statement

Clear and specific Code of Conduct

�Define acceptable and unacceptable behavior

�Address potential ethical dilemmas




Effective

Ethics/ Code of Conduct

Helps prevent misconduct

Detects violations and provides and earlywarning system

Timely and responsible actions help avertprosecution




Code of Conduct Checklist

- Use of equipment (telephone, vehicle,

photocopiers, scanner, supplies, creditcards)

- Use of the internet during work hoursand/or for non-work related reasons.

- Acceptance of gifts from vendors,suppliers and contractors




Code of Conduct Checklist(continued)

5. Conflicts of interest (sign form annually):Having direct or indirect, financial or

otherwise, in any transaction or activitythat conflicts with the proper dischargeof the employee·s duties.

6. Outside employment or dual

employment7. Confidential information

8. Intellectual property





9. Use of official position to secure

unwarranted privileges orexemptions

10. On-site weapons

11. Restricting competition

12. Computer security13. Time and attendance





14. Exercising common sense

15. Expense reimbursements16. Disparaging contractors

17. Illegal betting or gambling

18. Destruction of organizational records




Reasons for Failure

The message is not supported by seniormanagement

The ethics policy/code of conduct doesnot provide practical guidance or example

Regular training is not provided

Compliance officer is overburden withother matters




Reasons for Failure (continued)

People are not aware of the hotline

nor is it used Corrective actions are not initiated

Compliance is not monitored and anannual report is not issued




Periodically Reinforce Values

Annual training

Annual conflicts of interest affidavit Posted flyers

Reminders with W-2s




Periodically Reinforce Values(continued)

Weekly or monthly email reminders

about policies Code of conduct and ethics policy

posted on intranet

Posters advertising anonymousreporting mechanism






Effective Personnel Policies

Recruitment screening

Vacation policies

Appraisal system and counseling policies

Employee attitude surveys




Effective Personnel Policies

Recruitment screening� Verify identity

� Check qualifications, names of schools

� Probe employment gaps� Obtain references

Vacation policies and work patterns� Enforce vacations

Appraisal and counselingEmployee attitude surveys




Effective Personnel Policies(continued)

Background checks

Social security number verification

OFAC check

Media checks




An Effective Fraud andMisconduct Strategy

Fraud\misconduct awareness Typical fraud risks

Common indicators

Behavioral issues

Control benchmarking

Reporting fraud suspicions




Quality of Your Fraud and

Misconduct Strategy Score each of these on a 1 to 10 scale.

1. What is the quality of your anti-fraud andmisconduct strategy?

2. Is responsibility for managing fraud andmisconduct risk well defined?

3. How clear are reporting channels for reportingsuspicions of fraud or misconduct?

4. Are there clear protections for those reportingfraud or misconduct?

5. How effective is your fraud and misconductawareness program?



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Misconduct Strategy Score each of these on a 1 to 10 scale.

1. How effective is your recruitment screening process?

2. How developed is the understanding of fraud andmisconduct risks facing your organization?

3. How have you matched these risks to controls to seehow they are managed?

4. How effectively does your organization learn fromfraud and misconduct incidents?

5. How aware of fraud and misconduct are head officeand regional personnel?

W hat is the total score?



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How did your organization rate?

�90 to 100 points = Strong� 80 to 89 points = Effective

� 70 to 79 points = Needs Improvement

� 60 to 69 points = High Risk� Below 60 points = Very High Risk



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Indications of Low Fraud and

MisconductAwareness

No systems on fraud or

misconduct, it is not a

regular agenda item.

Do not believe there

is a structured way

of assessing risk.

No forum where the

subject of the

meeting is fraud and

misconduct risk.

People in the businessdo review fraud and

misconduct, but only in

a passive way.

The risk section isconsidered a cost

driver.I see the potential fraud

risks as nil to small.

The organization has

not considered fraud

risks. It trusts its

employees.



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Effective Fraud and Misconduct Reporting and Response Program

Fraud and misconduct reporting channels

Whistler blower protection and non-retaliation policy

Fraud and misconduct response plans



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Effective Fraud and

Misconduct Reporting and Response

Questions� Why investigate?

� When to investigate?

� What to investigate?� Who should investigate?

�How to conduct investigation?



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Effective Fraud and Misconduct

Reporting and Response (continued)

Importance of fraud risk management Every organization should have a documented anti-fraud

strategy and corporate integrity program. At a minimum itshould include:

� Agency·s stance on fraud and other breaches ofcompany·s policies and ethical code

� To whom and how should suspicions of fraud ormisconduct be reported

� What will be done and by whom in the case that fraud orother breaches are suspected

� Employee rights - including limitations on expectations ofprivacy and company·s rights to gain access and searchall work areas



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Why investigate?

�It·s your duty

�It·s the right thing



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Why it·s your duty

�Organizations have no choice» 1991 Sentencing Guidelines

» Prevalence of government voluntary

disclosure programs» Administrative and court rulings



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Why it·s the right thing� Best practice

» Conducting internal investigations is the norm ratherthan the exception

» 94% of companies responding to 1998 Fraud Survey saidthat conducting an investigation was the leadingresponse to the discovery of fraud

» Assists organizations in determining the extent of

potential civil or criminal liability» Assists in determining facts, available defenses, and

appropriate response

» Assist in negotiating a favorable resolution or avoidingan intrusive government investigation



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Why it·s the right thing Bottom Line protection

Deterrence Given the cost of fraud, a fraud response is essential

Recovery

Asset tracing and recovery

Insurance coverage

Public relations

Permits affirmative, proactive communications strategy

Avoids charge of cover up



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When to investigate

� Knowledge of information suggesting reasonablepossibility that a third party and/or an employeemight have engaged in wrongful conductexposing the organization to risk of criminalliability, substantial monetary loss or damage,

injury to its reputation, or other type of significantharm



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Reporting and Response (continued) When to investigate

� Timing

» Decision should be made as soon as possible

» Advantages of early start

Greater ability to develop appropriate response and defense Increases likelihood that corporations can gather information

and interview employees before government

Enables corporations to qualify for credit for full cooperationunder Sentencing Guidelines

» Importance of Fraud and Misconduct Response Plan as part of a

compliance program Corporation needs to be prepared in advance to insure

prompt and appropriate response



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What to investigate

� Fraud ² Internal or external» Falsification of financial data

» Misappropriation of assets

» Theft or embezzlement



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What to investigate

�Violations of organization policy» Examples Conflicts of interest

Policies regarding giving or receiving gifts

Waste/Mismanagement Mishandling of confidential or proprietary

information



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Effective Fraud and MisconductReporting and Response (continued)

Who should investigate� Chief of internal compliance (Integrity Officer)

» An individual should be designated by each organization towhom all information regarding potential misconduct should

be reported» Responsibility

To receive reports of fraud or misconduct

To conduct initial evaluation (refer to either HR or GC)

� General Counsel

» Responsibility

To determine seriousness of allegation To determine scope and direction of investigation

To consult and advise other relevant executives

To determine the need for retention of outside counsel



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Who should investigate

�All internal investigations shouldalways be directed by counsel

�Principal reason:» Permits invocation of privilege to protect

the confidentiality of internalinvestigative results



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!!!Assume all Cases

W ill End in Litigation!!!



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Findings Could Result in:

Civil Litigation

Criminal Litigation No Action



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False Imprisonment Occurs

W hen There Is

An intent to confine

An act resulting in confinement Consciousness of confinement

or resulting harm.



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H ow to investigate� Develop Investigative Hypothesis

» Theory of fraud or misconduct - Extent and elements

» Who may be involved

» Where is the evidence likely to be found Documents

Witnesses

Individual computers

Transportable media

Network servers

� Constantly refine and re-examine



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H ow to investigate� Develop Work Plan

» Consistent with theory of fraud or misconduct» Identify documents to be examined

» Procedures to be followed

Examples Document examination and verification

Types of analysis

Manual reviewGap, variance

Reconciliation

Sorting and comparisons

Trend



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H ow to investigate� Identify potential sources of electronic or voice information

and data

� Examples» PCs» Laptops» Transportable media» Network servers» Voice-mails

» Emails» Recorded conversations ² e.g. securities trading» Video tapes

� Procedures and tools to be used to retrieve electronic and voicedata



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H ow to investigate�Identify individuals to be interviewed

» Inside organization

» Outside organization ² e.g. vendors

�Develop interview menus» Order of interviews

» Questions to be asked

�Identify other investigative procedures» Public database searches

» Data analysis



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Res pecting employee rights

Employee Rights include:� Contractual Right

Example» If employee is a member of a union, union contract or

collective bargaining agreement may contain restrictions

on investigation procedures� Whistleblower laws

» Protect employees who report misconduct togovernment from retaliatory action



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An Effective Fraud and MisconductStrategy (continued)

Effective Compliance Program Standards and procedures that are reasonably

capable of preventing fraud and misconduct

High-level oversight

Due care in delegating discretionary authority

Effective communication of standards and procedures

(Training)

Monitoring and auditing of compliance program

Enforcement of program through discipline

Appropriate response upon notification of wrongdoing



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Federal Sentencing Guidelines for

an Effective Compliance ProgramHigh level oversight

Standards of conduct

Communications and trainingCompliance auditing and monitoring

Pre-employment screening

Enforcement of standards and disciplinaryactions

Corrective actions taken



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Fraud and misconduct

Reporting and response

Culture, values & ethics

Effective

Compliance Program

Reporting channels

Whistle blower protections

Response plans

Typical fraud risks

Common indicators

Behavioral issues

Control benchmarking

Reporting fraud

suspicions

Values statement

Code of Conduct

Defining acceptable and

unacceptable

Addressing ethicaldilemmas

Standards and procedures High-level oversight

Delegation due care

Training

Monitoring and Auditing

Discipline

Appropriate response

Fraud\ misconduct

awareness

Effective personnel policies

Recruitment screening

Vacation policies

Appraisal and counseling

Employee attitude surveys





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Objectives of a Fraud

Response Plan

Provide a conduit for whistleblowers

Identify internal affairs personnel Outline the manner in which all reviews

should proceed

Prevent further loss

Identify high risk areas



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Objectives of a Fraud

Response Plan

Respond quickly

Secure evidence Identify parties involved

Identify loss remedies

Identify specialists



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Best Practices (continued)

Third party receives complaints aboutbilling, collections and payments.

Clerk who issued bills, collected cash andreceived complaints misappropriated$357,000 via a lapping scheme involving

4,000 water utility customers.



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Bonding employees:

Estimate the amount and add a cushion(Nobody steals small amounts)



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Telephone Audits: www.google.com.Type in telephone number and hit

google search. 900 calls by mailman during lunch

Go out an let people know what your

doing. They don·t know who you·relooking at.



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Checking inventory annually to identifyexcess inventory



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Right to Audit

Obtaining the right:

Right to Audit Agreement -

on the back of purchase

order or procurement form

Right to Audit Clause in a

Contract - include language

in the body of the contract



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Compliance audits of purchasingpolicies (kickbacks and embezzlements)

Written policies and procedures



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The Value of Nothing

No telephone number is master vendor

file Telephone number is the same digit, i.e.

all 9·s

No address No contact person of fed ID #

P



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GrantAdministration

Right to audit

Purchasing vs. leasing

Tel Calls

Travel

Food Vendors

Subcontracts

Employees

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Questions?Chris Rosetti

[email protected]

BST Advisors, LLC26 Computer Drive WestAlbany, New York 12205

Tel: 518-459-6700 / 800-724-6700 Fax 518-459-8492

www.bstadvisors.com

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