Financial Services Fraud

1. Financial Services Fraud Jonathan B. Wolfe, CPA Director, Accume Partners

2. Agenda • Overview • Definition of Operational Fraud • Fraud Statistics • Fraud within Financial Services • Banking, Insurance, Investment Advisors/Broker Dealers • Risk Factors • What can an internal auditor do? • Fraud Risk Assessment • Employ Best Practices • Fraud Resources

3. Financial Services Fraud Overview

4. Definition of Occupational Fraud • The term “Occupational Fraud” may be defined as: “The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.”

5. Definition of Occupational Fraud All occupational fraud schemes have four key elements in common. The activity: • is clandestine; • violates the perpetrator’s fiduciary duties to the victim organization; • is committed for the purpose of direct or indirect financial benefit to the perpetrator; and • costs the employing organization assets, revenue, or reserves.

6. Occupational Fraud All occupational frauds fall into one of three major categories: • Asset Misappropriations, which involve the theft or misuse of an organization’s assets. • Corruption, in which fraudsters wrongfully use their influence in a business transaction in order to procure some benefit for themselves or another person, contrary to their duty to their employer or the rights of another. • Fraudulent Statements, which generally involve falsification of an organization’s financial statements.

7. Fraud Statistics Source: 2006 Association of Certified Fraud Examiners (ACFE) Report to the Nation 10- The Sum of Percentage in this chart exceeds 100% because in some cases respondents identified more than one detection method.

8. Fraud Statistics Source: 2006 ACFE Report to the Nation

9. Fraud Statistics Source: 2006 ACFE Report to the Nation • Banking and Financial Services Industry has the highest number of cases • Insurance was ranked 5th.

10. Fraud Statistics Source: 2006 ACFE Report to the Nation Where is it happening? • Accounting, Finance and Executives represents 55% of the cases. • While frauds committed by those in the highest age groups were the most costly on average, over two-thirds of the frauds reported were committed by employees in the 31-50 age group. The median age among perpetrators was 42. • Most of the perpetrators were either employees (41.2%) or managers (39.5%). Owner/executives (19.3%).

11. Fraud Statistics – Median Loss Source: 2006 ACFE Report to the Nation

12. Financial Services Fraud Fraud Within Financial Services

13. Fraud Within Financial ServicesSource: 2006 ACFE Report to the Nation Banking and Financial Services Fraud • Not surprisingly, two of the three most common schemes in the banking and financial services industry were cash larceny and skimming. These schemes generally involve the physical theft of incoming cash and cash on hand (for example, in a vault). • Among the 23 non-cash cases in this industry, the most common type of scheme involved the theft of proprietary information about bank customers. • Of the 148 cases, 80% were prosecuted.

14. Fraud Within Financial ServicesSource: 2006 ACFE Report to the Nation Insurance Fraud • Fraudulent billings represented nearly 30% of the insurance industry cases. These cases were nearly twice as common as the next-most-frequently reported scheme, which was check tampering. • Conversely, nearly 70% of the organizations in the insurance industry conducted fraud training for their employees and managers — a higher rate than for any other industry • Of the 78 cases, 74% were prosecuted.

15. Risk Factors • Incentives or pressures • Opportunities • Attitudes or rationalizations

16. Industry Fraud – Banking & Mortgage Banking • Notary • Volume pressures – Loans, Deposits • Appraisers • Artificially inflating home values • Check Fraud • Participating financial institutions can report all checking accounts "closed for cause" to a central database, called ChexSystems. This program prevents people, who have outstanding checks due to retailers, from opening new accounts. • Black Market Peso • Peso brokers laundering monies through the purchase of foreign goods.

17. Industry Fraud - Insurance • Premium Fraud • Premium fraud occurs when employers fraudulently misstate the number of employees or the nature of their work, such as reporting a roofer as an office worker. • Billing Fraud • Ohio pain management specialist threatened to deny desperate patients painkillers unless they let him use their names to bill insurance companies more than $60 million in narcotic drugs and expensive diagnostic tests he never gave. Some patients grew addicted, and two died of overdoses. He also fraudulently billed insurers for more than 100 patients a day for years. He received life in federal prison. • Employer or Insurance Carrier Fraud • In this type of fraud, employers or employees of an insurance carrier will make a false statement regarding a workers entitlement to benefits. The statement is designed to discourage the worker from pursuing a legitimate claim

18. Industry Fraud – Investment Advisors and Broker Dealers • Churning – Excessive Commission Scams • Discretionary Accounts • 3% or more commissions • Breakpoint Sales – Fee Scales • Over Concentration - brokers are obligated to advise their clients to diversify in order to decrease risk. • House Stocks - A "house stock" is essentially a stock that the firm wants people to buy in order to artificially increase its value. • Failure to Place an Order - broker is trying to inflate the value of a stock as part of an unethical investment scheme, it may be against his interests to sell the stock. • Unauthorized Trades - brokers who have had discretionary trading contracts with their clients may take advantage of their freedom and purchase "house stocks", or engage in other illicit trading practices designed to increase their earnings at the expense of their client.

19. Financial Services Fraud What can an Internal Auditor do?

20. What can an Internal Auditor do? Fraud Risk Assessment • Systematic Rather Than Haphazard or Informal • Address • Financial reporting • Misappropriation of assets • Expenditures and liabilities for improper purposes • Fraudulently obtained revenues and assets, and costs and expenses avoided by fraud • Fraud by senior management • Extend to Business Unit and Significant Account Levels • Likelihood: Identify Fraud Risks That Are “More Than Remote” • Significance: Identify Fraud Risks That Are “More Than Inconsequential in Amount: • Consider Risks of Management Override

21. What can an Internal Auditor do? Employ Best Practices • Develop a Fraud Policy • Enhance Audit Programs • Leverage your Sarbanes Oxley work • Educate Audit Committee and Boards • Evaluate Code of Ethics • Provide annual training programs • Integrate fraud monitoring into your enterprise risk management program • Implement a whistle blower policy • Discuss SAS 99 with your external auditors • Outside resources – CFEs, consultants • Technology – ACL, data mining

22. Does Internal Audit Make a Difference? YES! Source: 2006 ACFE Report to the Nation • Internal audits had a positive correlation with both time to detection and median loss. Fifty-nine percent of victim organizations had an internal audit or fraud examination department at the time of the fraud. • Similarly, organizations with internal audit departments detected their frauds in 18 months, as opposed to 24 months for those without internal audit departments.

23. Fraud Resources • The Institute of Internal Auditors • www.theiia.com • Association of Certified Fraud Examiners • www.cfenet.com • Securities and Exchange Commission • www.sec.gov • The Treasury Department • www.treas.gov • National White Collar Crime Center • www.nw3c.org

24. Financial Services Fraud Questions?