It never ceases to amaze that the largest financial frauds originate from such petty beginnings. From billion-dollar fraud cases such as WorldCom to international bank fraud to Ponzi schemes spanning decades, it is clear that even the largest and most complex financial fraud schemes often start from amazingly simple ideas.

According to a report by the Association of Certified Fraud Examiners (ACFE) on occupational fraud and abuse, nearly 90 percent of asset misappropriations involve cash.

This may not surprise many business owners. But it is unsettling to most executives that it takes an average of 18 months to uncover fraudulent activity. Often, the fraud activity’s complexity is not what prevents detection; rather, it is the entity’s failure to establish adequate internal controls that allows the fraud to flourish and continue.

For example, financial fraud may be detected when a company requests an increase to its bank line of credit. In some cases, the fraud perpetrators request the bank line to continue their theft, but the due diligence that arises from that request actually results in their own demise.

From an investigative accounting perspective, the forensic accountant’s role goes beyond the investigations of the internal auditor and/or the external auditor in connection with the annual audit conducted in accordance with generally accepted accounting principles.

The forensic accountant’s investigations routinely seek to identify areas of exposure that place an organization at risk of fraud. In instances where fraud is committed at the highest levels within an organization, it is not unusual to discover that the perpetrator’s fraudulent scheme is less sophisticated when compared to fraud committed at the lower levels of an organization.
 
Safeguard Your Company
The ACFE’s report highlights check tampering as the most common method of cash misappropriation. This usually occurs when only one person has access to the company’s checkbook. Business owners should reduce risk in this area by taking basic preventive measures.

These actions may include signing all checks personally, requesting that the company’s bank forward a copy of the company’s bank statements to their residence and comparing the bank statement against the company’s books and records. In addition, small business owners should periodically review their check registers for reasonableness and consistency with the business’ overall operations.

Businesses are challenged to identify where they are susceptible to fraud, but addressing that challenge allows them to develop and implement the internal controls necessary to detect and deter theft. Although this task is large, the costs of ignoring this task can be far greater – even catastrophic.  

A one-time fraud usually escalates into a continuing series of fraudulent actions. Even worse, the fraud with simple beginnings often becomes complex because the fraudulent actor wants to continue the fraud, but must also hide it. Since many businesses lack adequate internal controls to properly detect fraud, it is usually unforeseen circumstances rather than preemptive measures that ultimately result in detection.

In particular, middle-market companies are more likely to suffer from weak internal controls due to their lack of resources and the in-house expertise necessary to focus on those critical areas where fraud may arise. Forensic accountants are trained to recognize the financial red flags that point to the weak spots that might lead to fraud and white-collar crime.

For some companies, upgrading existing accounting systems can be a good first step. Archaic reporting systems should be replaced with more state-of-the-art technology that can assist in the detection of fraudulent activity. In addition, companies should consider implementing an employee fraud reporting system, such as an anonymous hotline. According to the ACFE, anonymous tips were the most common method of financial fraud detection in both 2004 and 2006.

Forensic Accountants
When fraud does occur, the best forensic accountants take an integrated approach to their investigations. This means they apply their accounting skills together with their other investigatory techniques for a unified investigation..

Perhaps more importantly, forensic accountants can be invaluable to the litigation process when a company seeks to recover its losses arising from fraud. In performing litigation support services, forensic accountants assist counsel in drafting interrogatories, document requests and deposition questions designed to elicit relevant information, and by attending depositions.

Further, they analyze the information produced during the discovery process and explain its significance to counsel. If necessary, they also attend the trial and assist counsel with the cross-examination of the adversary's witnesses.

Case Studies
In one engagement, forensic accountants served on behalf of the court as the independent accountant to ascertain the disposition of suspicious payments that were made to fund certain employer welfare plans. The investigation included the analysis of thousands of documents related to the funding and payment of medical claims.

In addition, the accountants traced cash receipts and disbursements to third-party documents to determine the validity of the transactions.

In another case, the validity and collectibility of a company’s accounts receivable were in question. The forensic investigation identified the existence of fictitious customers, fictitious sales, and forged bills of lading, invoices and other fraudulent documents.

It was determined that certain company officers were involved in a massive fraud resulting in U.S. and foreign bank losses of between $600 million and $1 billion. This resulted in the arrest of the company’s chief executive officer on charges of conspiracy to commit bank fraud, mail fraud and wire fraud. The company’s CFO and former treasurer were also arrested on similar charges.

In another matter, a leading financial institution wanted to quantify damages caused by a large jewelry manufacturer’s fraud that included the creation of fictitious customers and sales, manipulation and misposting of customers’ cash receipts, delays in recording returns and allowances and the creation of false borrowing base certificates. In this situation, forensic accountants helped mitigate the losses through the filing of income tax refund claims and collection of accounts receivables.

Again, as a result of the investigation conducted by forensic accountants, the company’s former president and controller were arrested and spent time in prison for their crimes.

While the determination of financial damages is generally one of the most important issues in a case, it could be the most uncertain. In computing or contesting damages, forensic accountants often need to determine what a party’s financial condition would have been, but for the fraudulent conduct. Lost profits may be a significant element of damages in cases involving breach of contract, business interruption, copyright or patent infringement, defamation or securities fraud.

Financial fraud can quickly snowball, and it is no surprise that it does so in an environment that lacks controls, oversight and accountability. In fact, such an environment is fertile ground that allows fraudulent activity to grow and flourish, at any level. But, with the help of forensic accountants, you can establish the proper controls, recognize the red flags and protect your organization against financial fraud.