Wk 7 Discussion (Investigating Fraud) - Post 1

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CHAPTER 14: CONDUCTING INVESTIGATIONS AND WRITING REPORTS

LEARNING OBJECTIVES

14-1 Understand the circumstances that may necessitate an internal investigation

14-2 Identify who should be part of a fraud examination team

14-3 Define evidence

14-4 Be familiar with several evidence-gathering techniques

14-5 Understand the considerations and concerns related to preserving documentary

evidence

14-6 Understand the importance of and methods for organizing documentary evidence

14-7 Identify several sources of evidence and the types of information each can provide

14-8 Be familiar with the standard format and requirements for a professional

investigation report

WHEN IS AN INVESTIGATION NECESSARY?

The need for an internal investigation can arise in a number of circumstances. Obviously,

such an examination may be necessary to determine the source of losses caused by

occupational fraud. A thorough investigation in these circumstances can help a company

reduce its losses, identify the perpetrator, gather evidence for a criminal prosecution or civil

trial, and recapture some or all of the amount stolen. It can also shed light on weaknesses in

the company’s control structure, thereby helping to shore up the company’s internal

defenses against future employee misconduct.

In addition to preventing losses resulting from fraud, an organization or its officers may

have legal duties to investigate alleged misconduct. Certain federal statutes, such as the

Foreign Corrupt Practices Act, are specifically aimed at detecting wrongful conduct and

require that companies report specific instances of misconduct. Obviously, to make an

accurate report of misconduct, the company will need to conduct an investigation into

alleged wrongdoing. Regulatory agencies such as the Securities and Exchange Commission

require accurate financial reporting by the companies they oversee, and they have the

power to impose penalties for reports that are inaccurate or that omit facts that could affect

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the accuracy of the reported information. An investigation can ensure that all relevant facts

are known and reported.

Officers and directors of companies are also bound by duties of loyalty and reasonable care

in overseeing the operations of their companies. This means they must act in

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the best interests of the company and take reasonable steps to prevent harm that the

company might suffer as a result of employee misconduct. The failure to investigate reliable

allegations of misconduct can amount to a violation of these duties, thereby subjecting the

director or officer to civil liability for any damages that the company incurs as a result of

the failure to investigate.

In many situations, companies must also conduct an internal investigation before they can

dismiss an employee who has committed fraud or otherwise violated company rules and

policies. A thoroughly documented investigation will help insulate the company from

charges that it discriminated against the employee or otherwise wrongfully terminated him.

Additionally, when an organization might be liable for the conduct of one of its employees,

an internal investigation can help mitigate the company’s liability by cutting off the

wrongful conduct before it is allowed to grow, and by demonstrating that the company has

an effective program to detect and prevent criminal misconduct by its employees—a factor

that provides for the diminishment of fines under the Organizational Sentencing Guidelines

(discussed in more detail in Chapter 16).

A company’s managers may find that the best way to fulfill these legal duties and

requirements is to conduct an internal investigation of known or suspected misconduct. Put

another way, by failing to adequately investigate an allegation of employee fraud, a

company may be failing to comply with the law. However, the decision to investigate is

often based on very specific facts, and whether an investigation is compelled by some other

legal duty or requirement is best determined by the company’s lawyer or lawyers, in

consultation with senior management and after considering all relevant facts.

PLANNING THE INVESTIGATION

Once the decision has been made to pursue an investigation, the focus shifts. The question is

no longer whether the company should investigate the matter, but rather how the company

can carry out the investigation in the most efficient, effective manner. The answer to this

primary question requires answering two secondary questions:

• Who will be involved in the investigation?

• What will be the investigative strategy?

Selecting the Investigation Team

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Internal investigations of fraudulent activity usually require a cooperative effort among

different disciplines. Auditors, fraud examiners, line managers, attorneys, security

personnel, and others are all frequently associated with fraud examinations. When

choosing an investigation team, it is critical to identify those who can legitimately assist in

the investigation and who have a genuine interest in the outcome of the examination. These

persons should be included on the investigative team, and all other personnel should be

segregated. There are a number of reasons for this. First, the more people involved in the

investigation, the greater the chance that one of those persons may be somehow implicated

in the fraud itself, or that one of those persons might leak confidential information about

the investigation. Second, the persons involved in the investigation team may have to testify

in legal proceedings, or the documents they generate may be subject to discovery, if the

investigation leads to civil litigation or criminal prosecution. By limiting the number of

investigators, the company can limit its exposure to discovery. In

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addition, any internal investigation, by its nature, can lead to harsh allegations against one

or more suspects. This in turn can lead to charges of defamation and invasion of privacy,

among others. These charges will be bolstered if it is found that the company spread

information about the suspects to people who did not have a legitimate interest in that

information. Therefore, by limiting the size of the investigation team, the company can limit

its exposure to certain accusations.

None of this is meant to imply that the company should exclude otherwise necessary

individuals from the fraud examination team simply out of fear of potentially harmful legal

repercussions. On the contrary: the primary goal should be to resolve the allegations of

fraud as thoroughly and efficiently as possible, and that requires that all necessary persons

be involved in the effort. However, companies should guard against including extraneous

personnel who add no real value to the team.

A typical investigation team might include the following types of professionals:

• Certified fraud examiners

• Legal counsel

• Internal auditors

• Security personnel

• IT and computer forensics experts

• Human resources personnel

• A management representative

• Outside consultants

Certified Fraud Examiners

A CFE is trained to conduct a complex fraud examination from inception to conclusion.

Fraud examinations frequently present special problems because they require an

understanding of complex financial transactions as well as traditional investigative

techniques. Security personnel might be well versed in investigative techniques, such as

interviewing witnesses and collecting and preserving evidence for trial, but they may not

know how to spot a fraudulent transaction on the company’s books. Auditors and

accountants, on the other hand, may recognize a fraud scheme but may not have the

training to conduct other aspects of an investigation. A CFE has training in all aspects of a

fraud examination and therefore can serve as a valuable “hinge” to the investigation team,

tying together the financial examination and more traditional investigative techniques.

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Legal Counsel

It is crucial to have counsel involved in and, in most cases, “directing” the investigation, at

least as far as the legal aspects are concerned. An internal investigation can be a veritable

hornet’s nest of legal questions: Should the company report the results of the investigation,

and to whom? How can the company preserve the confidentiality of the investigation? How

should the investigation be conducted so as to avoid lawsuits? What areas can the company

search, and what information can be gathered without violating an employee’s rights?

When and how can an employee be fired for wrongful conduct? These are just some of the

issues that investigators will face. The investigation team must have legal counsel on hand

to sort out these questions, lest the company risk exposing itself to greater danger than the

threat it is investigating. In addition, by having an attorney directing the investigation, the

company may be able to protect the confidentiality of its investigation under the attorney-

client privilege and the work product doctrine.

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Internal Auditors

Internal auditors are often used to review internal documentary evidence, evaluate tips or

complaints, schedule losses, and provide assistance in technical areas of the company’s

operations. As was pointed out earlier, auditors are frequently the people who detect

financial anomalies that lead to fraud investigations. They are expected to be able to

identify fraud indicators and notify management if an investigation is required, and they

are charged with assessing the probable level of complicity within the organization and

with helping design procedural methods to identify the perpetrators as well as the extent of

the fraud.

Security Personnel

Security department investigators are often assigned the “field work” stage of the

investigation, including interviewing outside witnesses and obtaining public records and

other documents from third parties. It is crucial that their work be integrated with the

financial side of the investigation so that the team does not devolve into two de facto

investigations, one for “financials” and one for “field work.” The process works best when

all aspects of the investigation are coordinated and focused on the same goal.

IT and Computer Forensics Experts

If fraud occurs, it is virtually certain that a computer will have been involved at some point.

A computer may have been used to create false documents or alter legitimate documents,

and the perpetrators may have used e-mail to communicate. The information technology

(IT) department may need to be part of an investigation to safeguard data until it can be

analyzed. IT personnel can also help identify what data is available and where it is located.

Computer forensics professionals should be used to capture and analyze digital data.

Because electronic data can be easily altered, only trained professionals should be used to

secure such data so that it can be analyzed more thoroughly without disturbing the original

files.

Human Resources Personnel

The human resources department should be consulted to ensure that the laws governing the

rights of employees in the workplace are not violated. Such involvement will lessen the

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possibility of a wrongful discharge suit or other civil action by the employee. Advice from a

human resources specialist might also be needed, although normally this person would not

directly participate in the investigation.

Management Representative

A representative of management or, in significant cases, the audit committee of the board of

directors, should be kept informed of the progress of the investigation and should be

available to lend necessary assistance. A sensitive internal investigation has virtually no

hope of success without strong management support.

Outside Consultants

In some cases, particularly those in which the suspect employee is especially powerful or

popular, it might be useful to employ outside specialists who are relatively immune from

company politics or threats of reprisals. Such experts might also have greater experience

and investigative contacts than insiders. In addition, some investigatory procedures, such as

forensic document analysis, require a high level of proficiency and expertise and should

therefore only be undertaken by professionals specifically trained in that field.

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DEVELOPING EVIDENCE

Once it has been determined that an investigation is warranted, the fraud examiner will

need to take steps to prove or disprove the allegation. This involves undertaking procedures

designed to collect and develop evidence. Evidence is anything perceivable by the five

senses, including any proof, such as testimony of witnesses, records, documents, facts, data,

or tangible objects, that is legally presented at trial to prove a contention and to induce a

belief in the minds of a jury.

In addition to interviewing witnesses (discussed in Chapter 15) and using public records

(discussed later in this chapter), investigating a case and obtaining evidence may involve

the following:

• Covert operations

• Surveillance

• Informants

• “Dumpster-diving”

• Subpoenas

• Search warrants

• Voluntary consent

Covert Operations

Covert operations may be used to obtain evidence regarding the allegation. In some cases,

they are the only way to prove a fraud, and thus must be carried out with the highest degree

of planning and skill. In a covert operation, the investigator assumes the identity of another

person—either real or fictitious—to gather evidence. The length of the operation might vary

depending on the type of case and what evidence is needed. A written plan detailing specific

objectives, time frames, and approvals should be developed prior to undertaking an

undercover operation.

The courts have deemed covert operations as an acceptable method of developing

information, provided there is sufficient probable cause that a crime has been committed.

Entrapment issues, however, are a concern that must be dealt with in covert operations

conducted by law enforcement. In private corporations, entrapment is generally not an

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issue, but consultation with legal counsel is strongly advised prior to conducting an

undercover operation.

Pretexting

Covert operations may occasionally involve pretexting, which is the practice of obtaining

information through some sort of falsehood or deception. The practice is not always illegal,

but it should be used with extreme caution. For example, if a fraud examiner is trying to

locate a witness or a suspect, she might call the person’s relative and pretend to be an old

high school friend who is looking for a phone number. Although this type of pretexting

generally is not illegal, it is illegal to obtain certain types of information, such as phone

records and financial records, through any type of falsehood. Additionally, investigators

should never impersonate a member of law enforcement, and they should never

impersonate an actual person (particularly the individual being investigated). To do so may

lead to charges of identity theft.

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The Hewlett-Packard (HP) pretexting scandal provides an excellent example of what can

happen when an internal investigation is not properly conducted. The HP scandal began in

2005, when officials at HP initiated a secret internal investigation to discover the source of

board room leaks. To uncover the source, HP’s chairman hired a team of investigators to

procure the private phone records of HP’s board members through pretexting. Through

such efforts, the investigation uncovered the source, and at a board meeting in May of 2006,

HP’s chairman informed the board of the investigation scheme and identified the source of

the leaks. After the board asked the offender to resign, a fellow HP director resigned in

protest of the pretexting methods used during the investigation. Although HP’s chairman

was confident that pretexting was permissible, she could not foresee the disastrous fallout

from the investigation. In 2006, the investigators hired by HP were charged with identity

theft, conspiracy, and wire fraud, and investigations into the company’s practices were

undertaken by the California attorney general’s office, the U.S. Attorney in San Francisco,

the FBI, the FCC, and the Securities and Exchange Commission. Ultimately, HP paid $14.5

million to the state of California, and the chairman was removed from her position. In

response to the scandal, the U.S. Congress passed the Telephone Records and Privacy

Protection Act of 2006, which makes it an offense to obtain confidential phone records by

pretending to be someone else.

Before engaging in any type of pretexting activity, investigators should consult with an

attorney to determine whether the information sought is protected by state or federal law as

well as whether the planned impersonation method is legally acceptable.

Surveillance

Surveillance, the secretive and continuous observance of a suspect’s activities, is another

investigative technique frequently used in developing evidence. A surveillance initiative

may be undertaken to obtain probable cause for search warrants, develop other

investigative leads, identify co-conspirators, gather intelligence, or locate people and things.

Informants

Informants are individuals who have specific knowledge of a criminal activity. They are

used extensively by law enforcement, and can also be used successfully in private

investigations if handled properly. Although informants can be extremely helpful in fraud

investigations, the fraud examiner should be cautious in all interactions with informants.

Because the reasons informants supply information vary—and can include revenge,

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financial reward, or clearing their consciences—informants may not be trustworthy. Thus,

the examiner should always document all contact with informants to help guard against

subsequent problems.

“Dumpster-Diving”

On occasion, an investigator might find it necessary to sift through a suspect’s trash to

obtain evidence and leads. Important documents and information concerning illegal

activity might be found in the perpetrator’s own garbage. The courts have upheld that

investigators may sift through trash without a search warrant, provided that the trash has

left the suspect’s possession. At that point, there is no longer the reasonable expectation of

privacy; thus it is fair game.

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Subpoenas

If evidence is held by other parties or is in uncontrolled locations, specific legal action is

required before attempting to obtain it. This usually takes the form of a subpoena or other

order from the court to produce the documents and records (including electronic records).

A subpoena duces tecum calls for the production of documents and records. Other forms of

court orders can be used to obtain witness evidence and statements. Subpoenas are only

available as part of an existing legal action, such as a grand jury investigation, pending

criminal charges, or a civil suit. Thus, if no legal action has been initiated, obtaining

documents by subpoena is not possible.

Search Warrants

There may be occasions when a fraud examiner will be called upon to assist law

enforcement or will request the assistance of law enforcement in a particular investigation.

If there is probable cause to believe that certain records are being used or have been used

in the commission of a crime, the law enforcement officer will prepare an affidavit for a

search warrant, which will detail the legal reasoning behind the request for the warrant.

Only a judge can issue a search warrant, and only law enforcement can seek and serve a

search warrant. Obtaining as much intelligence as possible regarding the location of the

potential evidence is very desirable before writing the search warrant affidavit. Therefore,

law enforcement personnel will often need guidance from the fraud examiner as they

conduct pre-search preparation.

Voluntary Consent

Documents can be obtained by voluntary consent. This is often the simplest means to obtain

documentation, and therefore, it is the preferred method in many fraud examinations.

However, certain circumstances, such as hesitancy to release private information, or

resistance by those involved in the scheme, may preclude obtaining voluntary consent for

access to documents. While consent can generally be either oral or written, if documents

are obtained from possible adverse witnesses or the target of the examination, it is

recommended that the consent be acknowledged in writing.

PRESERVING DOCUMENTARY EVIDENCE

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Even if the investigator is careful to obtain the evidence legally, the case can be lost if the

examination team fails to preserve the evidence so that it is accepted by the court. For the

evidence to be admissible, basic procedures in its handling must be followed. Evidence

submitted must be properly identified, and it must be established that the proper chain of

custody was maintained. In addition, proof must be provided that the evidence is relevant

and material to the case.

The following general rules should be observed with regard to the collection and handling

of documents:

• Obtain original documents when feasible. Make working copies for review; keep the

originals segregated.

• Do not touch originals any more than necessary; they might later have to undergo

forensic analysis.

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• Maintain a good filing system for the documents. This is especially critical when large

numbers of documents are obtained. Losing a key document is an unpardonable sin,

and may mortally damage the case. Documents can be stamped sequentially for easy

reference.

Chain of Custody

From the moment evidence is received, its chain of custody must be maintained for it to be

accepted by the court. This means that a record must be made when the item is received or

when it leaves the care, custody, or control of the fraud examiner. This is best handled by a

memorandum of interview with the custodian of the records when the evidence is received.

The memorandum should state:

• What items were received

• When they were received

• From whom they were received

• Where they are maintained

If the item is later turned over to someone else, a record of this should also be made—

preferably in memorandum form. All evidence received should be uniquely marked so that

it can be identified later. The preferable way is to initial and date the item; however, this

can pose problems in the case of original business records furnished voluntarily. For them,

a small tick mark or other nondescript identifier can be used. If it is not practical to mark

the original document, it should be placed in a sealed envelope, which should be initialed

and dated.

Preserving the Document

When initialing a document for future identification, fraud examiners should only do so in

a noncritical area and using a different type of writing instrument than was used for the

questioned writings on the document. The examiner should never write or make markings

on the original document other than his unobtrusive initials for identification. Likewise, a

document should not be folded, stapled, paper clipped, crumpled, or altered in any other

way that would affect or change it from its original condition. If the document is stored in

an envelope, the examiner should be careful not to write on the envelope and cause

indentations on the original document inside. Photocopies and laser-printed documents

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should always be stored in paper folders or envelopes, not transparent plastic envelopes,

which can result in the copies’ sticking to the plastic and destroying some features of the

document.

If fingerprint examinations are anticipated, the examiner should use gloves to handle the

documents. Tweezers can also help the examiner avoid leaving fingerprints, but they

should be used with caution, because they can leave indentations that might obscure faint

indented writings or the identifiable indentations that are sometimes left by photocopy and

fax machines. If any known people have inadvertently handled the documents with bare

hands, their names should be provided to the fingerprint specialist. It may also be necessary

to provide the expert with sets of inked fingerprints of these people for elimination

purposes.

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ORGANIZING DOCUMENTARY EVIDENCE

Keeping track of the amount of paper generated is one of the biggest obstacles in fraud

investigations. It is essential that any documents obtained be properly organized early on in

an investigation, and that they be continuously reorganized as the case progresses.

Remember—it is usually difficult to ascertain the relevance of the evidence early in the

case, so reevaluation throughout the investigation is critical. Good organization in complex

cases includes the following:

• Segregating documents by either witness or transaction. Chronological organization is

generally the least preferred method.

• Making a “key document” file for easy access to the most relevant documents. The

examiner should periodically review the key documents, move the less important

documents to backup files, and keep only the most relevant documents in the main file.

• Establishing a database early in the case if there is a large amount of information to

process. The database should include, at a minimum, the date of the document, the

individual from whom the document was obtained, the date obtained, a brief

description, and the subject to whom the document pertains.

Chronologies

A chronology of events should be commenced early in the case in order to establish the

chain of events leading to the proof. The chronology might or might not be made a part of

the formal investigation report; at a minimum, it can be used for analysis of the case and

placed in a working paper binder. Keep the chronology brief and include only information

necessary to prove the case. Making the chronology too detailed can defeat its purpose. The

chronology should be revised as necessary, adding new information and deleting that which

is irrelevant.

To-Do Lists

Another indispensable aid is the “to-do” list. The list, which must be updated frequently,

should be kept in a manner that allows it to be easily modified and used as a cumulative

record of investigation tasks. In a very complex case, the list can be broken into long-and

short-term objectives: that which must be done eventually (e.g., prove elements of a

particular count) and that which should be done tomorrow (e.g., conduct an interview or

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draft a subpoena). No matter how organized an examiner might be, some list of this nature

must be kept, lest important points be forgotten during the lengthy investigation.

Using Computer Software to Organize Documents and Other Data

Computers are one of the most valuable tools for fraud investigators. In complex fraud

cases, the amount of information to be examined can be enormous. Performed manually, an

investigation of a complicated fraud scheme could become overwhelming, requiring so

much time and effort that it might cease to be cost-effective. Use of a computer

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database, however, enables investigators to easily store and access pertinent information

about the case and the documents that have been assembled. Special software can also be

used to sort, chart, and graph the information in the database, making it easier to analyze

relationships and identify anomalies. The following are a few of the software programs

commonly used for case management and reporting:

• i2 Analyst’s Notebook

• CaseMap by CaseSoft

• NetMap by Alta Analytics

• MAGNUM Case Management Software

• Watson and PowerCase from XANALYS

SOURCES OF INFORMATION

A vast variety of information sources is available to the fraud examiner to assist in:

• Locating individuals or verifying their identity

• Researching assets or financial positions

• Documenting lifestyles and background information

• Discovering banking/creditor relationships

• Identifying business affiliations/associates

• Uncovering litigation history

In-House Sources

Some of the most useful information comes from within a subject’s employing organization.

If an investigator can gain access to a company’s records, he can learn a great deal about an

individual by examining routine in-house information on file. In-house sources include:

• Personnel files

• Internal phone records and voice mail

• Computer files and records

• Physical files and records

• Timesheets

• Financial records

• Prior audit or investigative files

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• Corporate policies and procedures

• Company communications to employees

• Access codes and user identification codes

• Security videos

Public Information

Of all the information available, public records can be one of the most encompassing,

challenging, and rewarding sources for an investigator. Public records are those records

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