Case study - Fraud and Organizational Corruption- Due in 10 hours

Types of Fraud

While there are many types of fraud, the most common fraud schemes that organizations must prevent include employee embezzlement, vendor fraud, customer fraud and financial statement fraud. Of these four types, employee embezzlement is the most common type of fraud. Employee embezzlement is the process where employees intentionally deceive their employers and take company assets. Examples of employee embezzlement include company workers who intentionally take cash, inventory, tools or other supplies from the organization.Vendor fraud , on the other hand, is the process by which vendors, or suppliers, take advantage of the firm. Vendor fraud often results in an overcharge for purchased goods, the shipment of inferior goods or the nonshipment of goods even though payment has been made. The United States government has often been in the news because major government vendors such as defense and other government contractors have significantly overcharged for goods and services. For example, United States suppliers have been accused of charging more than $20 for a single nail. Often vendor fraud is perpetrated through collusion between buyers and vendors. Once these vendors have overcharged for goods, they will often kickback , or return, a portion of the fraudulent funds to a purchasing agent who represents the organization.

When customer fraud takes place, customers either do not pay for goods purchased or get something for nothing. For example, in one case, a bank customer walked into a branch of a large bank and convinced the branch manager to give her a $525,000 cashier's check, even though she had only $13,000 in her bank account. The manager believed she was a very wealthy customer and didn't want to lose her business. Unfortunately for the bank, she proceeded to defraud the bank of over $500,000. Financial Statement Fraud , also often referred to as management fraud , involves situations where company management intentionally makes the company appear more profitable than it actually is. For example, over the last two decades, management teams at Enron, WorldCom, Parmalat, Adelphia, Waste Management and a number of other companies have intentionally manipulated the financial statements to deceive the public into believing that their respective organizations were more successful than they actually were. These executives engaged in financial statement fraud to increase the company's stock price, which increased their own net worth (as a result of stock options that each executive possessed). In each of these situations, executives were manipulating the financial statements on behalf of the organization instead of directly stealing from the organization.

Fraud Perpetrators

Those customers, employees and vendors who engage in fraud are often referred to as fraud perpetrators. Unfortunately, research suggests that anyone can commit fraud and become a fraud perpetrator. In fact, most fraud perpetrators are good people who, because of a series of bad decisions, find themselves engaging in fraudulent behavior.

In one situation, for example, a woman named Suzzyiv had worked for National Security Bank for 34 years and was an honest and trusted employee. Prior to her retirement, however, her granddaughter was born and Suzzy became addicted to the home shopping network where she would buy countless gifts for her new granddaughter. In just three years time, Suzzy embezzled over $600,000 from the bank to support this addictive habit. When the bank discovered the fraud, the bank took possession of Suzzy's home and retirement account. Her husband, who had no knowledge of the fraud, voluntarily contributed the proceeds of his retirement account to the bank as well. The bank took possession of virtually every asset the couple owned. In addition, Suzzy still owes the bank over $200,000 and has entered into a restitution agreement to pay the bank that money as well. Suzzy was convicted and incarcerated for one year. All of Suzzy's friends and family members, including her children, know that she is a convicted felon. When Suzzy was released from prison, she was ordered by the judge to seek active employment so she could start making restitution payments. If she fails to make the payments, she violates her parole agreement and must return to jail. Because of the laws governing banks, the bank was required to submit a criminal referral form to the Office of the Controller of the Currency (OCC) who, by law, was required to submit a copy of the referral to the FBI and the IRS. Because Suzzy did not pay any taxes on any of the stolen funds, the IRS levied fines, penalties, interest, and back taxes on Suzzy. Finally, after all of Suzzy's suffering, including nearly a year in jail, Suzzy's husband informed her that he could not handle the situation anymore and that he was filing for a divorce.

As can be seen in the previous example, when fraud occurs everyone loses. The fraud perpetrator suffers humiliation, financial consequences, possible jail time and job loss. The victim organization suffers negative publicity, lower employee moral, and a decrease in financial resources. Researchv suggests that fraud perpetrators can't be distinguished from other people on the basis of demographic or psychological characteristics. In fact, in order for perpetrators to be successful, they must be able to deceive their victims. As such, most fraud perpetrators have profiles that look like most other honest peoplevi. Fraud perpetrators often have traits that organizations seek for when hiring new employees, seeking out new clients, and selecting vendors. Fraud perpetrators are typically hard-working, well-dressed, easy-to-get along with, professional individuals. Because of this, when fraud does occur, the most common reaction by those around the fraud is denial as victims cannot believe that trusted colleagues have been dishonest.

Fraud Triangle

All frauds include the following elements: 1) A perceived pressure, 2) A perceived opportunity, and 3) Some way to rationalize the fraud as acceptable. These three elements are often referred to as the fraud triangle .

Figure 12-1: Fraud Triangle

Pressures

Every fraud perpetrator faces some kind of perceived pressure. Most pressures typically involve a financial need, although nonfinancial pressures, such as the need to report financial results better than actual performance, frustration with work, or even a challenge to beat the system can also motivate fraud.

Common financial pressures that victims face include greed, living beyond one's means, high bills, personal debt, poor credit, personal financial losses and unexpected financial needs. Each of these pressures has been associated with numerous frauds. Often, fraud perpetrators live lifestyles far beyond that of their peers. For example, when one perpetrator was caught stealing $1.3 million from his employer, it was discovered that he had spent the money on monogrammed shirts and gold cuff links, two Mercedes-Benz vehicles, an expensive suburban home, a beachfront condominium, furs, rings, and other jewelry for his wife, a new car for his father-in-law, and a country club membership. Financial pressures can occur suddenly or be long term. The fact that an employee has been an "honest" employee for a long time seems to make no difference when severe financial pressures occur or an individual perceives that such pressures exists.

Closely related to financial pressures are motivations created by vices such as gambling, drugs, alcohol, and expensive extramarital relationships. Vices are the worst kinds of pressures to commit fraud. Examples include female employees who embezzled because their children were on drugs and they couldn't stand to see them go through withdrawal pains and "successful" managers who, in addition to embezzling from their companies, burglarized homes and engaged in other types of theft to support their drug habits. Finally, work related pressures often influence individuals to engage in fraud. These work related pressures include getting little recognition for job performance, having a feeling of job dissatisfaction, the fear of losing one's job, being overlooked for a job promotion, and feeling underpaid.

Opportunity

A perceived opportunity to commit fraud, conceal it, and avoid being punished is the second element of the fraud triangle. If fraud perpetrators don't have an opportunity to commit fraud then fraud will never occur. Fraud often occurs because company management will allow one individual to have too much authorization over one function of the organization (in the form of writing checks, authorizing accounts, and/or providing access to sensitive company information). Organizations can decrease opportunities for fraud by creating an effective internal audit department, conducting control activities, engaging in segregation of duties and consistently using a system of authorization.

An internal audit department is a formal organizational department with the responsibility to audit various divisions of the organization. While internal auditors only discover about one fourth of all frauds (most frauds are discovered through tips, alert employees, or by accident), the presence of internal auditors provides a significant deterrent effect. Internal auditors also provide independent checks and cause perpetrators to question whether they can commit fraud and not be caught.

Another way that organizations can limit their susceptibility to fraud is to periodically perform a series of control activities. Control activities , or procedures, includes the process of routinely checking for errors in any area of the organization. Routinely inspecting the accounts payable ledger, indicating who has been paid over the last few weeks, would be a good example of a control activity. An individual who owns his or her own business and is the sole employee probably does not need many control procedures since he or she would have no incentive to engage in fraud. An owner wouldn't steal from him or herself, and an owner would never want to treat customers poorly. However, organizations that involve many employees must have control procedures so that the actions of employees will be congruent with the goals of management and the organization. Furthermore, with control activities, opportunities to commit and/or conceal frauds are eliminated or minimized. Good fraud detection and prevention efforts involve matching the most effective control activities with the various risks of fraud.

Segregation of duties involves dividing a task into two parts so that one person does not have complete control of the task. This form of control, like most preventive controls, is most often used when cash is involved. For example, when cash is received by an organization, one employee should record the cash and another employee should handle the cash. If one person did both jobs, then the employee could easily steal the cash and then record that a refund was given to a customer. However, when two employees perform these functions, such fraudulent activity is minimized.

A proper system of authorization ensures that only authorized personnel have access to sensitive company information. For example, computer passwords should be used on all company computers. Furthermore, signature cards and other protective devices should be required to access safe deposit boxes, to cash checks, and to perform other functions at financial institutions. Spending limits should also be placed on all employees so that employees are only able to spend what is in their approved budget.

Rationalization

Even though most fraud perpetrators have a history of engaging in dishonest acts, fraud perpetrators actually consider themselves to be honest individuals. Because fraud perpetrators consider themselves to be honest, they must rationalize away the dishonesty of their acts. Common rationalizations include statements like, "The organization owes me", "Nobody will get hurt", "I deserve more" and "It's for a good purpose." Unfortunately, fraud perpetrators aren't the only ones who engage in rationalization. For example, many college students rationalize excessive drinking, driving over the speed limit and/or the use of credit card spending among other activities. The difference is that fraud perpetrators engage in rationalization in order to take advantage of others.

It is interesting to note that most fraud perpetrators, when interviewed, say things like, "I intended to pay the money back. I really did." They are sincere. In the mind of the perpetrator, he or she really intended to repay the money, and since perpetrators judge themselves by their intentions, instead of their actions, they do not see themselves as criminals.

One of the most publicized white-collar criminals of the early 2000s was Dr. Sam Waksal, CEO of ImClone. Waksal was one of Wall Street's men of the moment. As CEO of ImClone, he had just sold an interest in a new cancer drug called Erbitux to Bristol-Myers for roughly $2 billion. Everyone expected that the Food and Drug Administration would soon approve the drug. Shortly thereafter, however, Waksal learned from a Bristol-Myers executive that the drug wouldn't be approved. The FDA was refusing to consider the Erbitux application - not because the drug didn't work, but because there was insufficient data to approve its use. New clinical trials would have to be conducted, and the price of ImClone stock was going to plummet. Based on this insider information, Sam Waskal told his daughter to sell her shares, thinking that the price was going to go down. He also tried to sell 79,000 of his own shares (roughly $5 million). Later on, when explaining his actions Waksal said the following: "I could sit there at the same time thinking I was the most honest CEO that ever lived. And, at the same time, I could glibly do something and rationalize it because I cut a corner, because I didn't think I was going to get caught. And who cared? Look at me. I'm doing 'X,' so what difference does it make that I do a couple of things that aren't exactly kosher?" In fact, Waksal's rationalization had allowed him to have a long history of ethical lapses, reckless behavior, and embellishing the truth. He had been dismissed from a number of academic and research positions for questionable conduct. One former colleague said, "Cutting corners for Sam was like substance abuse. He did it in every aspect of his life, throughout his entire life."

Detecting Fraud

While most managers understand the detrimental effects that fraud has on the organization, most managers are not aware that they can actually prevent fraud from occurring. In fact, most managers simply assume that internal controls and/or internal or external auditors will detect fraud and prosecute fraud perpetrators. However, research suggests that fraud is most often discovered through tips and complaints from colleagues and/or other employees. As such, managers are in the best position to detect fraud. It is the manager, not the auditors, who can easily identify when an employee's behavior changes, when an employee's lifestyle changes and/or when an employee engages in unethical behavior. Furthermore, if a co-worker notices dishonest activity happening within the organization, that employee will most likely contact the manager. If the manager simply dismisses the tip, then other employees will be less likely to inform the manager when dishonesty is occurring within the organization. As a result, a manager's behavior and attitude towards honesty and dishonesty will have a large influence on the organization and the amount of fraud that occurs. Whenever managers do receive tips or complaints, they must treat the tip and/or complaint with care. Individuals should always be considered innocent until proven guilty and should not be unjustly suspected or indicted.

Extravagant Lifestyles

Nearly all individuals who engage in fraud are under some type of financial pressure. Typically, these financial pressures are real. However, at times, these financial pressures are created through a series of bad decisions. Most fraud perpetrators will begin to steal from their employers in order to pay off these financial pressures. For example, a fraud perpetrator may steal from his or her employer in order to pay off large sums of credit card debt. The majority of fraud perpetrators will truly intend to pay back the stolen funds, although perpetrators never do pay the funds back.

Once an individual begins to steal from his or her employer, the perpetrator will almost never quit stealing. In fact, research suggests that once perpetrators pay off their immediate financial needs, they will continue to steal funds to pay for other, non-necessary goods in order to improve their lifestyle. These perpetrators will begin to buy expensive toys (such as cars and boats), remodel their homes, buy expensive jewelry, take expensive vacations, purchase a vacation home, and even buy expensive CDs, music, art and clothing. Very few, if any, fraud perpetrators actually save what they steal. As the perpetrator becomes more and more confident in the fraud scheme, he or she will continue to steal larger and larger amounts. This trend will continue until the fraud becomes so large that it is eventually discovered.

Research indicates that fraud perpetrators are people who take shortcuts to appear successful. The same motivation that motivates an individual to engage in stealing is the same motivation that compels perpetrators to seek immediate gratification. People who can delay gratification and spending are much less likely to possess the motivation to be dishonest.

In order to better understand how an otherwise honest individual can engage in fraud, consider the below confession from Dennis Greer who engaged in a fraud scheme known as kiting. Note: Kiting is a somewhat advanced fraud scheme where an individual continually writes checks from one bank account to cover spending in another bank account and vice-versa. In other words, kiting uses the float time between bank accounts to give the impression that there is money in both bank accounts. While understanding the specifics of kiting is not important, it is important to notice how the fraud became larger and larger until it was eventually discovered. Also, notice how Dennis's spending habits increased as the fraud continued.

"I, Dennis Greer, am making this statement on my own, without threat or promises, as to my activities in regard to the activity of kiting between Bank A and Bank B. As of May 20XX, I was having extreme emotional and financial difficulties. For religious reasons, I was required without notice to move out of where I was living, and I had no place to go. Also, my grandmother--the only family member I was close to--was dying. I had to live out of my car for 3 weeks. At the end of this time, my grandmother died. She lived in Ohio; I went to the funeral and returned with a $1,000 inheritance. I used this money to secure an apartment. The entire sum was used up for the first month's rent, deposit, and application fee. From that time, mid- June, until the first part of August, I was supporting myself on my minimum-wage job at the nursery. I had no furniture or a bed. I was barely making it. I was feeling very distraught over the loss of my grandmother and problems my parents and brother were having. I felt all alone.

The first part of August arrived, and my rent was due. I did not have the full amount to pay it. This same week, I opened a checking account at Bank B. I intended to close my Bank A account because of a lack of ATMs, branches, and misunderstanding. As I said, my rent was due, and I did not know how to meet it. On an impulse, I wrote the apartment manager a check for the amount due. I did not have the funds to cover it. I thought I could borrow it, but I could not. During the time I was trying to come up with the money, I wrote a check from my Bank B account to cover the rent check and put it into Bank A. I did not know it was illegal. I knew it was unethical, but I thought since the checks were made out to me that it wasn't illegal.

This went on for about a week--back and forth between banks. I thought I could get the money to cover this debt, but I never did. My grandmother's estate had been quite large, and I expected more money, but it was not to happen. After a week of nothing being said to me by the banks, I began to make other purchases via this method. I needed something to sleep on and a blanket and other items for the apartment. I bought a sleeper sofa, a desk, a modular shelf/bookcase, and dishes and also paid off my other outstanding debts--college loans, dentist bill, and credit. I was acting foolishly. No one had questioned me at the banks about any of this. I usually made deposits at different branches to try to avoid suspicion, but when I was in my own branches, no one said a thing. I thought maybe what I was doing wasn't wrong after all. So I decided to purchase a new car, stereo, and a new computer to use at home for work. Still, I did not have a problem making deposits at the banks. But, I was feeling very guilty. I knew I needed to start downsizing the "debt" and clear it up. I began to look for a better-paying job. Finally, last week I got a call from Bank B while I was at work. They had discovered a problem with my account.

I realized then that the banks had found out. Later that day, I got another call from Bank A. They told me that what I had been doing was illegal and a felony. I was in shock. I didn't know it was that bad. I realize now how wrong what I did was. From the start, I knew it was unethical, but I didn't know it was indeed a crime until now. I have had to do a lot of thinking, praying, and talking to those close to me about this. I am truly sorry for what I have done, and I don't EVER plan to do it again. All I want now is to make amends with the banks. I do not have the money to pay back either bank right now. I realize this hurts them. I want to try to set this right, whether I go to prison or not. I am prepared to work however long it takes to pay the banks back in full with reasonable interest from a garnishment of my wages from now until the full amount is paid and settled.

I committed this act because I was feeling desperate. I was emotionally a wreck and physically tired. I felt I didn't have a choice but to do what I did or return to living in my car. I know now that what I did was wrong, and I am very sorry for it. I am attempting to seek psychological counseling to help me deal with and resolve why I did this. I feel I have a lot to offer society, once I am able to clean up my own life and get it straightened out. I pray the bank employees and officers will forgive me on a personal level for the hardship my actions have caused them, and I want to make full restitution. I have done wrong, and I must now face the consequences. This statement has been made in my own words, by myself, without threat or promise, and written by my own hand."

- Dennis Greer

A change in an employee's lifestyle is one of the biggest indications that fraud may be occurring. While changes in an employee's lifestyle only provide circumstantial evidence of fraud (Indeed, lifestyle changes may be the result of inheritance, a change in a spouse's employment, the lottery, etc), it should still send a red flag to the manager that something might be amiss.

Unusual Behaviors

Research in psychology suggests that when an individual engages in fraud (especially first-time offenders) they often go through a series of emotions, including fear and guilt. Such emotions will often create additional stress in the life of the perpetrator and this additional stress is often seen by colleagues and co-workers. While no particular behavior will indicate fraud, co-workers will immediately notice a change in behavior. Someone that was nice and pleasant will become irritable and confrontational. A co-worker who is loud and boisterous will become shy and reserved (or vice-versa). Even perpetrators will notice their behavioral changes. For example, a woman who stole over $400,000 said, "I had to be giving off signals. I could not look anyone in the eye." A man who took over $150,000 from his employer stated, "Sometimes I would be so wound up I would work for 12 or 14 hours a day, often standing up. Other times, I would be so despondent I could not get off the couch for over a week at a time". It should be noted that just because a colleague engages in unusual behaviors doesn't necessary indicate that he or she is committing fraud. In fact, changes in behavior can be caused by a number of factors such as changes in sleep patterns, a new child, a divorce or marriage, a parent who is sick, or a number of other factors. The important thing to remember, however, is that both unusual behaviors and extravagant lifestyles should signal to managers that something might be wrong. Before a manager confronts any person about lifestyle changes, unusual behaviors, or any other indications of fraud, both legal and human resources should be identified so that the matter is handled in an ethical and legal manner.