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Financial Statement Fraud: Prevention and Detection, Second Edition

By Zabihollah Rezaee and Richard Riley
Copyright © 2010 by John Wiley & Sons, Inc.

Appendix
Summary of Six Recent
Fraud Studies

Corruption or Compliance—Weighing
the Costs: The 10th Global Fraud Survey PricewaterhouseCoopers’s 2007 Global
(2007–2008) by Ernst & Young1 Economic Crime Survey2

1. Corruption is still being seen by the busi- 1. Survey discloses that fraud remains a con-
nesses and executives as a prevalent prob- siderable problem for the business, no mat-
lem. One-fourth of the organizations ter what size of company it is. Over 43
surveyed responded that they experienced percent of the respondents stated that they
corruption of some sort within the last two suffered some kind of economic crime in
years. the last two years.
2. Significant number of respondents felt that 2. Respondents informed that after significant
corruption is getting worse. investment that companies made in fraud
3. Number of cases prosecuted in OECD control, some form of fraud became less of
grows drastically from 51 cases in 2005 to a threat, but most of them did not change
270 cases in 2007. much.
4. Businesses believe that laws and enforce- 3. Asset misappropriation became steadily
ments against bribery and corruption are less of a threat, while threats from money
getting stronger. Almost 70 percent of the laundering, intellectual property infringe-
respondents agreed to that statement. ment, and corruption and bribery have
increased.
5. Businesses are becoming more conscious
in implementing anticorruption policies 4. Survey indicated that all industries are
and procedures into their compliance prac- more or less equally exposed to fraud.
tices Over two-thirds of the respondents However, insurance sector has the highest
suppose that their company’s internal audit total average cost to business ($5,494,831).
teams have adequate knowledge to uncover It also reported the highest direct loss
corrupt practices through compliance- from fraud ($4,476,717) and spent, again
focused audit. on average, an additional $1,018,114 on
managing the issues resulting from it.
6. Survey revealed that knowledge of FCPA
and its requirements is insufficient. Fifty- 5. Accounting fraud is prevalent in transpor-
eight percent of senior in-house counsel tation and logistics (24 percent of the
were not familiar with FCPA. companies).
7. Survey disclosed that 44 percent of the 6. Study uncovered that the average loss from
companies did not have identifiable proce- financial fraud increased significantly over
dures in place to detect parties related to the last two years (from approximately
the government officials. $1.7 million in 2005 to $2.4 million in
2007).

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8. Most of the respondents agreed that setting 7. Asset misappropriation accounts for about
up the successfully operating compliance 30 percent of average fraud losses,
program is a must in today’s environment accounting fraud—12 percent.
to prevent instances of bribery and 8. 41 percent of fraud was detected by
corruption. chance; internal audit was able to detect
fraud in 19 percent of the cases, while
there was a large increase in the detection
coming from whistle-blowing system,
which indicates that companies are able to
create an effective corporate culture.

‘‘How Executives View the Fraud Control

KPMG Fraudster Survey 20073 Gap,’’ Delloite Forensic Center 20074

1. Study demonstrates that fraud more likely 1. Companies perceive themselves as being
will take place at the financial depart- less effective when it come to dealing
ment, sales/operations, or the CEO level. with external fraud than internal fraud.
2. Ninety-one percent of the fraud executors 2. Executives at the companies that perceive
performed multiple fraud transactions that their fraud control system is effective
rather than a single transaction; every anticipated the instances of fraud will less
third executor performed more than 50 likely occur in the next 12 months.
transactions. Anticipations were divided as follows:
3. Paramount motives were indicated as 38 percent of the total answers anticipate
greed and opportunity (73 percent of the misappropriation of assets to occur,
profiles). 27 percent anticipate self-dealing fraud,
and 24 percent anticipate improper
4. Forty-nine percent of respondents speci-
expenditures.
fied that internal control was too weak to
prevent fraudulent actions. 3. The higher proportion of the senior exec-
utives is involved in fraud control system,
5. Sixty-nine percent of the fraudulent
the more effective the control is, but
actions were performed by the company’s
seemingly appears to be part but not all of
own employees, while the remaining
what drives higher fraud control
20 percent were performed by company’s
performance.
employees along with external perpetra-
tors, and only 11 percent of the actions 4. Formal fraud control policies and strate-
were performed by solely external indi- gies become are rapidly becoming a stan-
viduals. So, employees represent the dard. Fifty percent of the respondents
highest risk. overall said that they a formal fraud con-
trol or policy.
6. The most effective methods for the fraud
detection are whistle-blowing programs 5. More effective companies address most
and management reviews. fraud topics extensively in their fraud
control policies or strategies.
7. In 50 percent of the cases, companies did
not publicize the details of the fraud 6. Effective companies in 70 percent of the
within the organization. Companies prefer cases conduct formal fraud risk assess-
ments, especially when it comes to the
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Appendix 325

to communicate information concerning critical issues such as management

fraud details selectively. override.
8. All sectors are equally affected by the 7. Whistle-blowers hotlines were adopted by
white-collar crime, except for the chemi- 81 percent of the companies, but only 32
cals, biotech, and pharmaceuticals percent of the executives emphasized that
sectors. their whistle-blowing hotline was
9. Every tenth fraudulent case was detected effective.
only after five years. That statistic 8. Survey revealed an extensive opportunity
emphasizes the need for actions in the for the improvement in the area of train-
area of fraud risk management. ing employees about fraud control.
10. Most of the respondents agreed that cer- 9. Executives recognize the role of technol-
tain action should take place in order to ogy in fraud monitoring and 28 percent
mitigate fraud consequences and prevent confirmed that the intensification of the
fraud. use of technology will likely occur in a
next 12 months.
10. Forty-eight percent reported an increase
in recourses devoted to the fraud due it
increased publicity.

2008 Report to the Nation to the Occupational 2008 Corporate Fraud Task Force Report
Fraud and Abuse (ACFE)5 to the President6

1. Respondents indicate that they lose 7 per- 1. According to the report, the Department of
cent of their annual revenue because of Justice has obtained nearly 1,300 corporate
the fraud. fraud convictions since 2002.
2. More than one-forth caused at least $1 2. The FBI has undertaken several proactive
million in losses. Securities Fraud Market Manipulation ini-
3. Typical fraud usually lasted for at least tiatives that aggressively pursue corrupt
two years before it was detected. participants in the financial markets.
4. Financial statement fraud fell into the 3. The number of the investigations initiated
costliest categories, with a median loss of increased significantly from 40 in 2006 to
about $2 million among the 99 financial 124 in 2007.
misstatements studied. 4. Significant decline in incarceration rate can
5. Forty-six percent of the fraud cases were be observed in the last two years. The de-
detected by tips from affiliated parties. cline in FY2007 incarceration rate is the
Consequently, tips are the most common result of a larger number of sentenced
method of fraud detection. cases identified as a corporate entity in the
FY2007 data, when compared to FY2006.
6. Study revealed that implementation of the
Corporate entities do not result in months
fraud control systems leads to a reduction
to serve, and therefore reduce the incarcer-
of the median losses from fraud.
ation rate.
7. Fraud affects many industries, but it is
5. According to the U.S. Postal Inspection
more likely to occur in financial services
Service Corporate Fraud Investigations
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326 Appendix

(15 percent), government (12 percent), Statistics Fiscal Years 2004–2007 table,
and health care (8 percent). criminal fines obtained increased from
8. Small businesses appear to be more vulner- $599,138 in 2006 to $19,185,000 in 2007.
able to fraud and usually have the higher 6. Corporate fraud investigations involve the
losses. following activities: false accounting
9. Lack of the adequate internal control was entries, bogus trades designed to inflate
cited as a most significant factor that profits or hide losses, or false transactions
allows fraud to proliferate by 35 percent of designed to evade regulatory oversight.
the respondents. 7. Self-dealing insiders overlooked by the
DoJ and FBI include the following prac-
10. Most companies alter their antifraud con- tices: insider trading, kickbacks, backdat-
trols after they discover they have been de- ing of the executive stock options, misuse
frauded. The most typical change was to of corporate properties for personal gain,
conduct management reviews of the inter- and individual tax-violations related to
nal controls (56 percent of the cases), then self-dealing.
implementation of the surprise audit, then 8. Fraud in connection with an otherwise
fraud training for employees and managers. legitimately operated mutual or hedge fund
includes late trading, certain market timing
11. 29 percent of the fraud cases were commit- schemes, falsification of net asset values,
ted by someone in the accounting depart- other fraudulent or abusive trading prac-
ment; 18 percent was committed by tices by, within, or involving a mutual or
executives and upper management. hedge fund.

Web links in order to the presentation in the table, from left to right:

1. info.worldbank.org/etools/antic/docs/Resources/Corruption_or_compliance_
weighing_the_costs.pdf.
2. www.pwc.com/extweb/onlineforms.nsf/weblookup/GXENGCRIM2007Global
economiccrimesurvey:Download.
3. www.kpmg.co.uk/pubs/ProfileofaFraudsterSurvey(web).pdf.
4. www.deloitte.com/dtt/cda/doc/content/us_dfc_tenthingsfraudcontrol_200808%282%29
.pdf.
5. www.acfe.com/documents/2008-rttn.pdf.
6. www.usdoj.gov/dag/cftf/corporate-fraud2008.pdf.