Legal Elements of Fraud

Under common law, fraud includes four essential elements:

1. A material false statement
2. Knowledge that the statement was false when it was spoken
3. Reliance on the false statement by the victim
4. Damages resulting from the victim’s reliance on the false statement

In the broadest sense, fraud can encompass any crime for gain that uses deception as its principal technique. This deception is implemented through fraud schemes: specific methodologies used to commit and conceal the fraudulent act. There are three ways to relieve a victim of money illegally: by force, trickery, or larceny. Those offenses that employ trickery are frauds.

The legal definition of fraud is the same whether the offense is criminal or civil; the difference is that criminal cases must meet a higher burden of proof. For example, let’s assume an employee who worked in the warehouse of a computer manufacturer stole valuable computer chips when no one was looking and resold them to a competitor. This conduct is certainly illegal, but what law has the employee broken? Has he committed fraud? The answer, of course, is that it depends. Let us briefly review the legal ramifications of the theft.

The legal term for stealing is larceny, which is defined as “felonious stealing, taking and carrying, leading, riding, or driving away with another’s personal property, with the intent to convert it or to deprive the owner thereof.”³ In order to prove that a person has committed larceny, we would need to prove the following four elements:

1. There was a taking or carrying away
2. of the money or property of another
3. without the consent of the owner and
4. with the intent to deprive the owner of its use or possession.

In our example, the employee definitely carried away his employer’s property, and we can safely assume that this was done without the employer’s consent. Furthermore, by taking the computer chips from the warehouse and selling them to a third party, the employee clearly demonstrated intent to deprive his employer of the ability to possess and use those chips. Therefore, the employee has committed larceny.

The employee might also be accused of having committed a tort known as conversion.⁴ Conversion, in the legal sense, is “an unauthorized assumption and exercise of the right of ownership over goods or personal chattels belonging to another, to the alteration of their condition or the exclusion of the owner’s rights.”⁵ A person commits a conversion when he or she takes possession of property that does not belong to him or her and, thereby, deprives the true owner of the property for any length of time. The employee in our example took possession of the computer chips when he stole them, and, by selling them, he has deprived his employer of that property. Therefore, the employee has also engaged in conversion of the company’s property.

Furthermore, the act of stealing the computer chips also makes the employee an embezzler. “To embezzle means willfully to take, or convert to one’s own use, another’s money or property of which the wrongdoer acquired possession lawfully, by reason of some office or employment or position of trust.” The key words in that definition are “acquired possession lawfully.” In order for an embezzlement to occur, the person who stole the property must have been entitled to possession of the property at the time of the theft. Remember, possession is not the same as ownership. In our example, the employee might be entitled to possess the company’s computer chips (to assemble them, pack them, store them, etc.), but clearly the chips belong to the employer, not the employee. When the employee steals the chips, he has committed embezzlement.

We might also observe that some employees have a recognized fiduciary relationship with their employers under the law. The term fiduciary, according to Black’s Law Dictionary, means “a person holding a character analogous to a trustee, in respect to the trust and confidence involved in it and the scrupulous good faith and candor which it requires. A person is said to act in a ‘fiduciary capacity’ when the business which he transacts, or the money or property which he handles, is not for his own benefit, but for another person, as to whom he stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part.” In short, a fiduciary is someone who acts for the benefit of another.

Fiduciaries have a duty to act in the best interests of the person whom they represent. When they violate this duty, they can be liable under the tort of breach of fiduciary duty. The elements of this cause of action vary among jurisdictions, but in general, they consist of the following:

1. A fiduciary relationship existed between the plaintiff and the defendant
2. The defendant (fiduciary) breached his or her duty to the plaintiff
3. The breach resulted in either harm to the plaintiff or benefit to the fiduciary

A fiduciary duty is a very high standard of conduct that is not lightly imposed. The duty depends upon the existence of a fiduciary relationship between the two parties. In an employment scenario, a fiduciary relationship is usually found to exist only when the employee is “highly trusted” and enjoys a confidential or special relationship with the employer. Practically speaking, the law generally recognizes a fiduciary duty only for officers and directors of a company, not for ordinary employees. (In some cases, a quasi-fiduciary duty may exist for employees who are in possession of trade secrets; they have a duty not to disclose that confidential information.) The upshot is that the employee in our example most likely would not owe a fiduciary duty to his employer, and therefore he would not be liable for breach of fiduciary duty. However, if the example were changed so that an officer of the company stole a trade secret, that tort might apply.

But what about fraud? Recall that fraud always involves some form of deceit. If the employee in question simply walked out of the warehouse with a box of computer chips under his or her coat, this would not be fraud, because there is no deceit involved. (Although many would consider this a deceitful act, what we’re really talking about when we say deceit, as reflected in the elements of the offense, is some sort of material false statement that the victim relies upon.)

Suppose, however, that before he put the box of computer chips under his coat and walked out of the warehouse, the employee tried to cover his trail by falsifying the company’s inventory records. Now the character of the crime has changed. Those records are a statement of the company’s inventory levels, and the employee has knowingly falsified them. The records are certainly material, because they are used to track the amount of inventory in the warehouse, and the company relies on them to determine how much inventory it has on hand, when it needs to order new inventory, etc. Furthermore, the company has suffered harm as a result of the falsehood, because it now has an inventory shortage of which it is unaware.

Thus, all four attributes of fraud have now been satisfied: the employee has made a material false statement, the employee had knowledge that the statement was false, the company relied upon the statement, and the company has suffered damages. As a matter of law, the employee in question could be charged with a wide range of criminal and civil conduct: fraud, larceny, embezzlement, or conversion. As a practical matter, he or she will probably only be charged with larceny. The point, however, is that occupational fraud always involves deceit, and acts that look like other forms of misconduct, such as larceny, may indeed involve some sort of fraud. Throughout this book, we study not only schemes that have been labeled fraud by courts and legislatures but any acts of deceit by employees that fit our broader definition of occupational fraud and abuse. As you see later in Chapter 1, our recommended investigative approach does not require that you identify the specific law that was violated. Rather, the goal is to examine the relevant evidence with an eye toward demonstrating three attributes of the fraud:

• The scheme or fraud act
• The concealment activity
• The conversion or benefit

This approach ensures a careful and thorough examination of the issue without causing the forensic accountant to make decisions better suited to an attorney’s expertise. We’ll also use a thorough and careful examination of evidence associated with forensic accounting issues; again, this approach permits legal professionals to make determinations of which specific laws are relevant to the case facts and circumstances.

Major Categories of Fraud

• Asset misappropriations involve the theft or misuse of an organization’s assets. (Common examples include skimming cash and checks, stealing inventory, and payroll fraud.)
• Corruption entails the unlawful or wrongful misuse of influence in a business transaction to procure personal benefit, contrary to an individual’s duty to his or her employer or the rights of another. (Common examples include accepting kickbacks and engaging in conflicts of interest.)
• Financial statement fraud and other fraudulent statements involve the intentional misrepresentation of financial or nonfinancial information to mislead others who are relying on it to make economic decisions. (Common examples include overstating revenues, understating liabilities or expenses, or making false promises regarding the safety and prospects of an investment.)

Enron founder Ken Lay and former chief executive officer (CEO) Jeff Skilling were convicted in May 2006 for their respective roles in the energy company’s collapse in 2001. The guilty verdict against Lay included conspiracy to commit securities and wire fraud, but he never served any prison time because he died of a heart attack two months after his conviction. Skilling, however, was sentenced on October 23, 2006, to twenty-four years for conspiracy, fraud, false statements, and insider trading. In addition, Judge Lake ordered Skilling to pay $45 million into a fund for Enron employees. Former Enron chief financial officer (CFO) Andrew Fastow received a relatively light sentence of six years for his role, after cooperating with prosecutors in the conviction of Lay and Skilling.⁶ Enron was a $60 billion victim of accounting maneuvers and shady business deals that also led to thousands of lost jobs and more than $2 billion in employee pension plan losses.

If you were working at Enron and had knowledge of this fraud, what would you do?

On January 14, 2002, a seven-page memo, written by Sherron Watkins, was referred to in a Houston Chronicle article. This memo had been sent anonymously to Kenneth Lay and begged the question, “Has Enron Become a Risky Place to Work?” For her role as whistleblower, Sherron Watkins was recognized along with WorldCom’s Cynthia Cooper and the FBI’s Coleen Rowley as Time Magazine’s Person of the Year in 2002.

The Association of Certified Fraud Examiners defines financial statement fraud as the intentional, deliberate misstatement, or omission of material facts or accounting data that is misleading and, when considered with all the information made available, that would cause the reader to change or alter his or her judgment or decision.⁷ In other words, the statement constitutes intentional or reckless conduct, whether by act or omission, that results in material misleading financial statements.⁸

Even though the specific schemes vary, the major areas involved in financial statement fraud include the following:

The essential characteristics of financial statement fraud are (1) the misstatement is material and intentional and (2) users of the financial statements have been misled.

In the early 2000s, the financial press had an abundance of examples of fraudulent financial reporting.

These include Enron, WorldCom, Adelphia, Tyco, and others. The common theme of all these scandals was a management team that was willing to “work the system” for its own benefit and a wide range of stakeholders—including employees, creditors, investors, and entire communities—that are still reeling from the losses. In response, Congress passed the Sarbanes–Oxley Act (SOX) in 2002. SOX legislation was aimed at auditing firms, corporate governance, executive management (CEOs and CFOs), officers, and directors. The assessment of internal controls, preservation of evidence, whistleblower protection, and increased penalties for securities fraud became a part of the new business landscape.

The ACFE 2016 Report to the Nations on Occupational Fraud and Abuse noted that financial fraud tends to be the least frequent of all frauds, accounting for only about 10%. However, the median loss for financial statement fraud is approximately $1 million, more than eight times larger than the typical asset misappropriation and approximately four times larger than the typical corruption scheme. In addition, when financial statement fraud has been identified, in 80% of the cases, other types of fraud are also being perpetrated.

Common Fraud Schemes

Table 1-1 depicts the most common fraud schemes.

Suspected frauds can be categorized by a number of different methods, but they are usually referred to as either internal or external frauds. The latter refers to offenses committed by individuals against other individuals (e.g., con schemes), offenses by individuals against organizations (e.g., insurance fraud), or organizations against individuals (e.g., consumer frauds). Internal fraud refers to occupational fraud committed by one or more employees of an organization; this is the most costly and most common fraud. These crimes are more commonly referred to as occupational fraud and abuse.

The Fraud Tree was developed in 1996 by Dr. Joseph T. Wells, Founder and Chairman of the ACFE (Figure 1-1). This tool for classifying major categories of fraud has withstood the test of time. It helps readers understand fraud based on the type of scheme (assets misappropriation, corruption, and financial statement fraud) as well as important subcategories. Each type of fraud has specific elements required to perpetrate and conceal the fraud. As such, detection can be targeted by likely symptoms and investigation can be tailored.

Nonfraud Forensic Accounting and Litigation Advisory Engagements

The forensic accountant can be expected to participate in any legal action that involves money, following the money, performance measurement, valuation of assets, cost measurement and any other aspect related to a litigant’s finances, financial performance and/or financial condition. In some cases, the finances of the plaintiff are at issue; in some cases, the finances of the defendant are at issue; and in some disputes, the finances of both are under scrutiny, and the forensic accountants may be asked to analyze, compare, and contrast both the plaintiff’s and defendant’s finances and financial condition.

Some of the typical forensic and litigation advisory services may be summarized as follows:

• Damage claims made by plaintiffs and in countersuits by defendants
• Workplace issues, such as lost wages, disability, and wrongful death
• Assets and business valuations
• Costs and lost profits associated with construction delays
• Costs and lost profits resulting from business interruptions
• Insurance claims
• Divorce and matrimonial issues
• Fraud
• Antitrust actions
• Intellectual property infringement and other disputes
• Environmental issues
• Tax disputes
• Employment issues related to lost income and wages

The issues addressed by a forensic accountant during litigation may or may not be central to the allegations made by the plaintiff’s or defense attorneys, but they may serve to provide a greater understanding of the motivations of the parties, other than those motivation claims made publicly, in court filings and in case pleadings.

The Cost of Fraud and Other Litigation

Based on world GDP, in 2014, the ACFE estimated that the cost of fraud may be as high as $3.7 trillion annually. Even though this number is staggering in size, it hides the potentially disastrous impact at the organizational level. For example, if a company with a 10% net operating margin is a victim of a $500,000 fraud or loses a comparable amount as a result of a lawsuit, that company must generate incremental sales of $5 million to make up the lost dollars. If the selling price of the average product is $1,000 (a computer, for example), the company would need to sell an additional 5,000 units of product.

Organizations incur costs to produce and sell their products or services. These costs run the gamut: labor, taxes, advertising, occupancy, raw materials, research and development—and, yes, fraud and litigation. The cost of fraud and litigation, however, are fundamentally different from the other costs—the true expenses of fraud and litigation are hidden, even if a portion of the cost is reflected in the profit and loss figures. The indirect costs of fraud and litigation can have a far-reaching impact—employees may lose their jobs; the company may have difficulty getting loans, mortgages, and other forms of credit; the company’s reputation may be adversely affected; and the company may become the target of broader investigations. With regard to either litigation or fraud, prevention and deterrence are the best medicines. By the time a formal investigation is launched and the allegations are addressed within the legal arena, the organization has already incurred substantial costs.

ACFE 2016 Report to the Nations on Occupational Fraud and Abuse

The ACFE began a major study of occupational fraud cases in 1993, with the primary goal of classifying occupational frauds and abuses by the methods used to commit them. There were other objectives, too. One was to get an idea of how antifraud professionals—CFEs—perceive the fraud problems in their own companies.

The ACFE 2016 Report to the Nations on Occupational Fraud and Abuse is a result of what has now become a biannual national fraud survey of those professionals who deal with fraud and abuse on a daily basis.

Fraud Schemes Corresponding With the Fraud Tree

The ACFE highlights three major types of occupational fraud and abuse: asset misappropriation, corruption, and financial reporting fraud. The relative frequency and losses associated with each are as follows:

Fraud Scheme Category	Percentage	Median Losses
Asset Misappropriation	85	$130,000
Corruption	37	$200,000
Financial Reporting Fraud	9	$1,000,000

These percentages do not add up to 100% because many frauds involve multiple schemes. Within asset misappropriation, which has the most diversity, the heat map of frequency and loss (Figure 1-3) provides a broader view of the risk to victims.

Corruption is sometimes hypothesized to be especially common in cultures where “gratuities” are part of the business climate. As such, Figure 1-4 offers insight into corruption by regions of the world.

As the duration of the fraud lengthens, the cost of fraud increases. As noted in Figure 1-5, organizational efforts to detect fraud earlier should result in less impact. The median fraud lasts about eighteen months, according to the ACFE.

For the first time in the history of the Report to the Nations, the 2016 survey queried CFEs on the most common tactics to conceal fraud schemes. As the graphic in Figure 1-6 notes, the most common concealment schemes are “old fashioned” document-based efforts. Across time, antifraud professionals might see more electronic (technological) concealment. In the near term, traditional red flags are likely going to be grounded in physical evidence. While some differences across fraud categories were observed, generally, concealment is similar for asset misappropriation, corruption, and financial fraud schemes.

Tips (i.e., whistleblowing, hotlines) remain firmly as the most frequent means by which fraud is detected as shown in Figure 1-7. In the 2016 data, internal audit (16.5%) edged out management review (13.4%) as the second-most common detection method. Historically, external audits detected only about 3% of frauds. This is likely due to the materiality threshold incorporated into the external audit process. As noted above, the median loss, especially for asset misappropriation which is the highest frequency of fraud at 85%, is relatively low. As such, external auditors may not sample and examine transactions associated with the fraud scheme included in the ACFE study. The role of the external audit, as it relates to detecting fraud, is the subject of much professional and researcher attention.

The following chart offers a deeper look at tips by identifying the source of the tip.

Source of the Tip	Percentage
Employee	51.5
Customer	17.8
Anonymous	14.0
Other	12.6
Vendor	9.9
Shareholder/Owner	2.7
Competitor	1.6

The Effect of Position on Median Loss

Fraud losses tended to rise based on the perpetrator’s level of authority within an organization (see Figure 1-8). Generally, employees with the highest levels of authority are the highest paid as well. Therefore, it was not a surprise to find a positive correlation between the perpetrators’ position and the size of fraud losses.

The lowest median loss of $65,000 was found in frauds committed by employees. Although the median loss in schemes committed by managers reached $173,000, the median loss skyrocketed to $703,000 for executives/owners. Approximately 18.9% of the schemes are committed by executives/owners.

The Effect of Gender on Median Loss

The 2016 ACFE Report to the Nation showed that male employees caused median losses that were more than twice as large as those of female employees; the median loss in a scheme caused by a male employee was $187,000, whereas the median loss caused by a female employee was $100,000. The most logical explanation for this disparity seems to be the “glass ceiling” phenomenon. Generally, in the United States, men occupy higher-paying positions than their female counterparts. And as we have seen, there is a direct correlation between median loss and position. Furthermore, in addition to higher median losses in schemes where males were the principal perpetrators, men accounted for 69.0% of the cases, as Figure 1-9 shows.

The Effect of Age on Median Loss

The age range of fraud perpetrators in the study ran the gamut from young to senior citizen. There was a strong correlation between the age of the perpetrator and the size of the median loss (see Figure 1-10), which was consistent with findings from previous reports. Although there were very few cases committed by employees over the age of sixty (2.5%), the median loss in those schemes was $630,000. By comparison, the median loss in frauds committed by those twenty-five or younger was $15,000. As with position and gender, age is likely a secondary factor in predicting the loss associated with an occupational fraud, generally reflecting the perpetrator’s position and tenure within an organization.

Although frauds committed by those in the older age groups were the most costly on average, almost two-thirds of the frauds reported were committed by employees 31−50 years old. The median age among perpetrators was 40.

The Effect of Education on Median Loss

As employees’ education levels rose, so did the losses from their frauds (Figure 1-11). The median loss in schemes committed by those with only a high school education was $90,000, whereas the median loss caused by employees with a postgraduate education was $300,000. This trend was to be expected, given that those with higher education levels tend to occupy positions with higher levels of authority.

The Effect of Collusion on Median Loss

It was not surprising to see that in cases involving more than one perpetrator, fraud losses rose substantially. The majority of 2016 survey cases (52.9%) only involved a single perpetrator, but when two or more persons conspired, the median loss was more than seven times higher (see Figure 1-12).

Criminal History of the Perpetrators

Most people who commit occupational fraud are first-time offenders. Only 5.2% of the perpetrators identified in the 2016 study were known to have been convicted of a previous fraud-related offense. Another 5.5% of the perpetrators had previously been charged but never convicted. These figures are consistent with previous studies. It is also consistent with Cressey’s model, in which occupational offenders do not perceive themselves as lawbreakers. With regard to employment history, approximately 8.3% had been previously terminated for fraud-related offenses.

The ACFE presented survey respondents with a list of 17 common behavioral red flags associated with occupational fraud and asked them to identify which, if any, of these warning signs had been displayed by the perpetrator before the fraud was detected. In more than 91% of cases, at least one behavioral red flag was identified prior to detection, and in 57% of cases two or more red flags were seen. The behavioral red flags and their frequency are presented in Figure 1-13.

Median Loss Based on Type of Organization

Private companies can face challenges in deterring and detecting fraud that differ significantly from those of other organizations. The data show that these private organizations tend to suffer disproportionately large fraud incidents—the median loss for fraud cases attacking private organizations was $180,000, similar to that of public companies ($178,000). This exceeded the median loss for cases in other organization types: government, not-for-profit and other (Figure 1-14).

Median Loss Based on Size of the Organization

Small businesses (those with fewer than 100 employees) tend to suffer a disproportionately large number of fraud incidents and fraud losses, similar to findings in prior reports. One exception: companies with 100–999 employees (for the 2016 survey only) had median fraud losses that exceeded those of smaller organizations by $36,000 (see Figures 1-15 and 1-16).

The data for median loss per number of employees confirm what was always suspected. Antifraud professionals logically conclude that small organizations are particularly vulnerable to occupational fraud and abuse. The results from fraud surveys bear this out: losses in the smallest companies were comparable to, or greater than, those in organizations with the largest number of employees. It is suspected that this phenomenon exists for two reasons. First, smaller businesses have fewer divisions of responsibility; therefore, fewer people must perform more functions. One of the most common types of fraud encountered in these studies involved small business operations that had a one-person accounting department—that employee writes checks, reconciles the accounts, and posts to the books. An entry-level accounting student could spot the internal control deficiencies in that scenario, but apparently many small business owners cannot or do not.

Which brings up the second reason losses are so high in small organizations: There is a greater degree of trust inherent in a situation where everyone knows one another personally. None of us like to think that our coworkers would, or do, commit these criminal offenses. Our defenses are relaxed because we generally trust those we know. There again is the dichotomy of fraud: it cannot occur without trust, but neither can commerce. Trust is an essential element in business—we can, and do, make handshake deals every day. Economic transactions simply cannot occur without trust. The key is seeking the right balance between too much, and too little, trust.

Remediation

A crucial step in the remediation process is understanding how a fraud occurred, as well as how to prevent and deter future occurrences. In hindsight, it can be difficult to pinpoint the exact system breakdowns that allowed a fraud to occur. However, learning from past fraud incidents is necessary to better prevent and detect future fraud schemes. Consequently, the ACFE survey asks respondents for their perspective on the internal control weaknesses at the victim organization that contributed to the fraudster’s ability to perpetrate the scheme. A clear lack of internal controls was cited as the primary issue by 29.3%, with another 20.3% stating that internal controls were present but had been overridden by the perpetrator (see Figure 1-18).

Criminal Prosecutions and Their Outcome

In 59.3% of the cases, the victim organization referred the case to law enforcement authorities.

For cases that were referred to law enforcement authorities, a large number of those cases were still pending at the time of the survey as shown in Figure 1-19. However, for those cases that were resolved, the percentage of defendants who pleaded guilty or no contest has remained fairly constant over time. The rate of cases in which authorities declined to prosecute dropped from 19.2% in 2012 to 13.3% in 2016. Combining guilty pleas and convictions at trial, 76.4% of cases submitted for prosecution resulted in a finding of guilt in 2016, while 2.3% of such prosecutions ended in acquittal. Although the percentage of cases referred to prosecution decreased gradually from the 2012 to the 2016 reports, the percentage of cases that prosecutors successfully pursued increased.¹⁴

No Legal Action Taken

One goal of the ACFE study was to try to determine why organizations decline to take legal action against occupational fraudsters. In cases where no legal action was taken, the survey provided respondents with a list of commonly cited explanations and asked them to mark any that applied to their case. Figure 1-20 summarizes the results. Fear of bad publicity (39.0%) was the most commonly cited reason, followed by internal discipline was sufficient (35.5%) and a private settlement being reached (23.3%).

The Mindset: Critical Thinking and Professional Skepticism

As previously noted, we observe that individuals who commit fraud look exactly like us, the average Joe or Jane. If typical fraudsters have no distinguishing outward characteristics to identify them as such, how are we to approach an engagement to detect fraud?

It can be challenging to conduct a forensic accounting engagement or fraud examination unless the investigator is prepared to look beyond his or her value system. In short, the most effective way to catch a fraudster, is to think like one. In a forensic accounting engagement, such as a breach of a contract, the examiner needs to focus on what actions were taken, when they were taken, and if the underlying facts and circumstances are consistent with the actions of the plaintiff or defendant.

PCAOB AS 2401.13 states that “Due professional care requires the auditor to exercise professional skepticism.” Because of the characteristics of fraud, the auditor should conduct the engagement “with a mindset that recognizes the possibility that a material misstatement due to fraud could be present.” It also requires an “ongoing questioning” of whether information the auditor obtains could suggest a material misstatement as a result of fraud.

Professional skepticism can be broken into three attributes:

1. Recognition that fraud may be present. In the forensic accounting arena, it is recognition that the plaintiff and/or the defendant may be masking the true underlying story that requires a thorough analysis of the evidence
2. An attitude that includes a questioning mind and a critical assessment of the evidence
3. A commitment to persuasive evidence. This commitment requires the fraud examiner or forensic accountant to go the extra mile to tie up all loose ends

At a minimum, professional skepticism is a neutral but disciplined approach to detection and investigation. AS 2401 suggests that an auditor neither assumes that management is dishonest nor assumes unquestioned honesty. Professional skepticism, conceptually, drives forensic accounting engagements; keeping an open mind and letting the evidence guide one’s opinions and conclusions. In practice, professional skepticism, particularly recognition, requires that the fraud examiner or forensic accountant “pull on a thread.”

Loose threads: When you pull on a loose thread, a knitted blanket may unravel, a shirt may pucker and be ruined, or a sweater may end up with a hole. Red flags are like loose thread: pull and see what happens; you just might unravel a fraud, ruin a fraudster’s modus operandi, or blow a hole in a fraud scheme. Red flags are like loose threads: left alone, no one may notice, and a fraudster or untruthful litigant can operate unimpeded. A diligent fraud professional or forensic accountant who pulls on a thread may save a company millions of dollars.

Fraud Risk Factors and “Red Flags”

What do these loose threads look like in practice? Fraud professionals and forensic accountants refer to loose threads as anomalies, relatively small indicators, facts, figures, relationships, patterns, and breaks in patterns, suggesting that something may not be right or that the arguments being made by litigants may not be the full story. These anomalies are often referred to as red flags.

Red flags are defined as a warning signal or something that demands attention or provokes an irritated reaction. Although the origins of the term red flag are a matter of dispute, it is believed that, in the 1300s, Norman ships would fly red streamers to indicate that they would “take no quarter” in battle. This meaning continued into the seventeenth century, by which time the flag had been adopted by pirates, who would hoist the “Jolly Roger” to intimidate their foes. If the victims chose to fight rather than submit to boarding, the pirates would raise the red flag to indicate that, once the ship had been captured, no man would be spared. Later it came to symbolize a less bloodthirsty message and merely indicated readiness for battle. From the seventeenth century, the red flag became known as the “flag of defiance.” It was raised in cities and castles under siege to indicate that there would be “no surrender.”¹⁵

Fraud professionals and forensic accountants use the term red flags synonymously with symptoms and badges of fraud. Symptoms of fraud may be divided into at least six categories: unexplained accounting anomalies, exploited internal control weaknesses, identified analytical anomalies where nonfinancial data do not correlate with financial data, observed extravagant lifestyles, observed unusual behaviors, and anomalies communicated via tips and complaints.

Although red flags have been traditionally associated with fraudulent situations, forensic accountants are also on the lookout for evidence that is inconsistent with their client’s version of what happened. As independent experts, forensic accountants need to look for evidence that runs counter to their client’s claims. Opposing council is always looking for weaknesses in your client’s case, so whether the professional is investigating fraud or other litigation issues, it is critical that the forensic accountant maintain a sense of professional skepticism, look for red flags, and pull on loose threads.

Fraud risk factors generally fall into three categories:

• Motivational: Is management focused on short-term results or personal gain?
• Situational: Is there ample opportunity for fraud?
• Behavioral: Is there a company culture for a high tolerance of risk?

Evidence-Based Decision Making

Evidence and other legal issues are explored in depth in a later chapter. For now, we’ll use the information in Black’s Law Dictionary, which defines evidence as anything perceivable by the five senses and any proof—such as testimony of witnesses, records, documents, facts, data, or tangible objects—legally presented at trial to prove a contention and induce a belief in the minds of a jury.¹⁶ Following the issues of critical thinking and professional skepticism is that of a commitment to evidence-based decision making. One of the best ways to ruin an investigation fails to gain a conviction, or lose a civil case is to base investigative conclusions on logic and conjecture. Many people have tried to convict an alleged perpetrator using the “bad person” theory. The investigator concludes that the defendant is a “bad guy” or that he or she will not come off well during trial and, therefore, must be the perpetrator or have done something wrong. Unfortunately, this approach fails to win the hearts and minds of prosecutors, defense lawyers, and juries, and it can result in significant embarrassment for fraud professionals or forensic accountants.

What do we mean by evidence-based decision making? Critical thinking requires the investigator to “connect the dots,” taking disparate pieces of financial and nonfinancial data to tell the complete story of who, what, when, where, how, and why (if “why” can be grounded in evidence). Dots can be business and personal addresses from the Secretary of State’s office, phone numbers showing up in multiple places, patterns of data, and breaks in patterns of data. These dots help prosecutors, defense lawyers, and juries to understand the full scheme under investigation. However, to be convincing, fraud professionals or forensic accountants must ensure that the dots are grounded in evidence that is consistent with the investigators’ interpretation of that evidence. The bottom line is this: successful investigators base their conclusions, and the results of their investigations, on evidence.

Scope of the Engagement

One of the biggest challenges that new forensic accountants and fraud examiners face is limiting their work to the scope of the engagement. For most fraud allegations, the engagement is much more limited in comparison to an audit. A financial statement audit is about the fairness of the financial reports (balance sheet, income statement, and statement of cash flows); this is a much broader scope than an investigation related to allegations of inappropriate expense disbursements, for example. Audits are conducted in compliance with generally accepted auditing standards (GAAS).

Regarding tax engagements: The AICPA’s Statements on Standards for Tax Services (SSTSs Standards Nos. 3 and 4) and Treasury Department Circular 230, Regulations Governing Practice Before the Internal Revenue Service (IRS), identify tax preparers’ responsibilities related to practice before the IRS. The responsibilities are different, for example, than those associated with the narrow allegations of missing deposits and inappropriate expense disbursements. Tax preparers’ generally are not required to search for malfeasance, as long as they have no reason to believe that the books and records, provided by the client to prepare tax returns, have been tainted.

Whether the engagement is based on allegations associated with a civil litigation claim or a tip about a fraud act, the forensic accountant or fraud examiner needs to ensure that they have a clear understanding of the concerns. These allegations or concerns define the initial scope of the engagement. The professional needs to focus on, and examine, evidence likely to help him draw conclusions regarding the allegation(s). Not surprisingly, a fraud allegation concerning a billing scheme might spread to include travel reimbursement fraud; however, the initial effort should focus on the allegation(s) asserted, while the discovery of new evidence might lead to an expanded engagement. Similarly, in a civil litigation case, the allegations are outlined in the complaint filed with the court, and are clarified or updated over time with pleadings, discovery responses, motions and disclosures. The effective forensic accountant stays focused on the allegations and works in concert with attorneys to obtain the relevant evidence and examine the claims.

The Problem of Intent: Investigations Centered on the Elements of Fraud

Although the fraud triangle helps to explain the conditions necessary for fraud to occur, to prove fraud, the investigator has to deal with the issue of intent. Intent, like all aspects of the investigation, must be grounded in the evidence. In a fraud case, the challenge is that—short of a confession by a co-conspirator or the perpetrator—evidence of intent tends to be circumstantial. Although less famous than the fraud triangle, the triangle of fraud action, also known as the elements of fraud, is critical to the investigative process, whether the engagement includes fraud or litigation issues. The elements of fraud shown in Figure 1-21 include the act (e.g., fraud act, tort, breach of contract), the concealment (hiding the act or masking it to look like something different), and the conversion (the benefit to the perpetrator).

Provided that the investigator has evidence that the alleged perpetrator committed the act, benefited from that act, and concealed his or her activities, it becomes more difficult for the accused (the defendants) to argue that they did not intend to cause harm or injury. Evidence of concealment, in particular, provides some of the best evidence that the act, fraud or otherwise, was intentional. In civil litigation, especially damage claims based on torts and breach of contract, the elements of fraud remain important: for example, what evidence suggests that a tort occurred (The Act), how did the tortuous actors benefit from their action (Conversion), and how did the tortuous actors cover up their activities (Concealment).¹⁷

Evidence of the act may include that gathered by surveillance, invigilation, documentation, posting to bank accounting, missing deposits, and other physical evidence. Proof of concealment can be obtained from audits, document examination, and computer searches. Further, conversion can be documented by using public records searches, tracing cash to a perpetrator’s bank account, and indirectly using financial profiling techniques. Finally, interviewing and interrogation are important methods that can be used to supplement other forms of evidence in all three areas: the act, concealment, and conversion. There is an ongoing debate in the profession about whether tracing money to a perpetrator’s bank account is good enough evidence of conversion, or whether the investigator needs to show how the ill-begotten money was used. Although tracing the money into the hands of the perpetrator or his or her bank account is sufficient, showing how the money was used provides a more powerful case and can provide evidence of attributes of the fraud triangle, such as pressure and rationalization, and other motivations included in M.I.C.E, discussed in Chapter 2. Generally, investigators should take the investigation as far as the evidence leads.

Examples of circumstantial evidence that may indicate the act, concealment, or conversion include the timing of key transactions or activities, altered documents, concealed documents, destroyed evidence, missing documents, false statements, patterns of suspicious activity, and breaks in patterns of expected activity.

The Analysis of Competing Hypotheses (The Hypothesis-Evidence Matrix)

In most occupational fraud cases, it is unlikely that there will be direct evidence of the crime. There are rarely eyewitnesses to a fraud, and, at least at the outset of the investigation, it is unlikely that the perpetrator will come right out and confess. Therefore, a successful fraud examination may take various sources of incomplete circumstantial evidence assembled into a solid, coherent case that either proves or disproves the existence of fraud. Civil litigation, by its very nature, suggests that there are at least two competing stories, that of the plaintiff and another of the defendant. Thus, as a starting point in civil litigation, the forensic accountant normally has at least two competing hypotheses. It is incumbent on the professional to use the evidence to test each of the hypotheses, as well as others that may arise based on reasonable, objective interpretation of the evidence.

To conclude an investigation without finding all the evidence related to a case is not unusual for the fraud examiner and forensic accountant. No matter how much evidence is gathered, the fraud and forensic professional would always prefer more. In response, these professionals utilize the fraud theory approach. This is not unlike the scientist who postulates a theory based on observation and then tests it. When investigating complex frauds, the fraud theory approach is indispensable. Fraud theory begins with an assumption of what might have occurred, based on the known facts. Then that assumption is tested to determine whether it is plausible and able to be proven. The fraud theory approach involves the following steps, in the order of their occurrence:

• Gather related data/evidence.
• Analyze available data.
• Create hypotheses.
• Test the hypotheses.
• Refine and amend the hypothesis.
• Draw conclusions.

Methodologies Used in Fraud Examinations and Forensic Accounting Engagements

Essentially three tools are available, regardless of the nature of the fraud examination or forensic accounting engagement. First, the fraud examiner or forensic accountant must be skilled in the examination of financial statements, books and records, and supporting documents. In many cases, these provide the indicia of fraud and/or the motivations of the parties under review. Related to such evidence, the fraud examiner must also have familiarity with the legal ramifications of evidence and how to maintain the chain of custody over evidence. For example, if it is determined that Linda Reed Collins was taking payoffs from a supplier, contracts, purchase orders, invoices, checks and other financial records related to the case must be lawfully obtained and analyzed. Ultimately, conclusions that are reached must be legally supportable.

The second tool used by these professionals is the interview, which is the process of obtaining relevant information about the matter in question from those with knowledge of it. For example, in developing information about Linda Reed Collins, it might be necessary to interview her co-workers, superiors, and subordinates. In civil litigation, most interview testimony is obtained by counsel during depositions. Despite the fact that forensic accountants do not ask the questions, it is common for them to prepare questions for attorneys to ask, attend depositions of key financial personnel and those knowledgeable about the entity’s finances, and provide the attorney with feedback and additional questions during the deposition of fact witnesses, who have financial knowledge related to the matters at hand.

In a fraud examination, evidence is usually gathered in a manner that moves from the general to the specific. That rule applies both to gathering documentary evidence (Figure 1-22) and to taking witness statements (Figure 1-23). Therefore, a fraud examiner most likely starts by interviewing neutral third-party witnesses, persons who may have some knowledge about the fraud but who are not involved in the offense. For example, the fraud examiner may start with a former employee of the company. Next, the fraud examiner interviews corroborative witnesses, those people who are not directly involved in the offense but who may be able to corroborate specific facts related to the offense.

If, after interviewing neutral third-party witnesses and corroborative witnesses, it appears that further investigation is warranted, the fraud examiner proceeds by interviewing suspected co-conspirators in the alleged offense. These people are generally interviewed in order, starting with those thought to be least culpable and proceeding to those thought to be most culpable. Only after suspected co-conspirators have been interviewed is the person suspected of committing the fraud confronted. By arranging interviews in order of probable culpability, the fraud examiner is in a position to have as much information as possible by the time the prime suspect is interviewed. The methodology for conducting interviews is discussed later in the text.

The Importance of Nonfinancial Data

The power of using nonfinancial data to corroborate financial information cannot be overstated. How are nonfinancial data defined? They are data from any source outside of the financial reporting system that can be used to generate an alternative view of the business operation. Consider the following example, in which a husband in a divorce case argued for a low settlement for his ex-wife:

A large restaurant sold Southern food and beer, with beer sales being a prominent part of the restaurant. The owner reported only $50,000 of annual income from the business, yet he and his wife drove expensive cars, their children attended private schools, and the husband was buying significant amounts of real estate. Records of the local beer distributors were subpoenaed. Those records detailed exactly how much beer and the types of beer (kegs, bottles, cans, etc.) that were sold to the restaurant during the prior two years. A forensic accountant went to the restaurant and took note of all the beer prices by type. The amount of beer purchased was used to estimate sales by pricing all the purchases at retail. Reported sales were found to be approximately $500,000 less than the estimated sales calculated by the forensic professional.¹⁹

In this case, the nonfinancial data were units of beer purchased and obtained from beer distributors, a source outside the normal accounting reporting function. As examples, similar approaches can be used to estimate laundromat electricity usage, laundromat wash and dry cycle times, natural gas produced from gas wells, and tons of coal mined from underground. Nonfinancial data need not come from sources outside the company; they can be generated from internal operations and used by management. A patented data mining technique called NORA (nonobvious relationship awareness) was created to assist in determining the relationships between people.

Essentially, economists break the world into prices and quantities (p’s and q’s). Fraud examiners and forensic accountants use this same approach to evaluate expected business relationships. Once critical metrics have been dissected into prices and quantities, each can be evaluated for reasonableness to determine whether the numbers make sense or if further investigation is needed. Nonfinancial data can then be correlated with numbers represented in the financial accounting system: financial statements and tax returns. Examples of nonfinancial data include employee records and payroll hours, delivery records, shipping records, attorney hours charged, the number of customer complaints, and travel times and destinations. Any data generated outside the normal accounting system can be used to determine the reasonableness of data generated from accounting. Optimally, the nonfinancial data can be reconciled to, or at least correlated with, the numbers captured in the books and records.

The theory behind the power of nonfinancial data is straightforward. Essentially, managers of operational areas need accurate data to do their jobs. Consider managers in a petroleum-refining business. Petroleum refining is a sophisticated mixture of chemistry and engineering. Without accurate, reliable, and detailed data, managers cannot optimize the refining processes. Although owners and those responsible for the financial data may want to create alternative perceptions of financial performance, they still want the underlying business to maximize profitability. As such, they are not likely to corrupt nonfinancial data. Further, they need to hold operational managers accountable for their performance, and they cannot achieve that goal without accurate nonfinancial data. Finally, even though some executives and financial managers are willing to cook the books, they are not willing to forgo large tax deductions and other benefits from their actions. When nonfinancial data do not reconcile or correlate to financial data, fraud examiners and forensic accountants should consider this a red flag. Finally, in most fraud examinations and forensic accounting engagements, professionals should seek out nonfinancial data to understand fully the information included in the accounting books and records.

Dates are also critical nonfinancial numbers. Allegations of fraud or a civil complaint will include a time period when the bad acts may have occurred. The fraud examiner and forensic accountant normally attempt to solicit data before, during, and after the timeframe of the alleged acts. It’s critical to monitor this period around which the illegal acts are alleged to have occurred because they might offer relevant insight into the act, the concealment, and/or the conversion.

Graphical Tools

As noted in some of the critical thinking analyses, sometimes the only way to figure something out is to use graphical tools—such as, who knows who (linkages), who is connected with what business, how the scheme works (flow diagram), who must be involved (links and flows), what the important events are (timelines). During the investigation, these graphical representations, even handwritten ones, can provide important clues and enhance the investigator’s understanding of fact and events, interpret evidence, and otherwise draw meaning from seemingly disparate pieces of data. They can also show weaknesses in the case—places where additional evidence is required to provide a complete evidence trail.

Although completed during the investigation as a work-in-progress tool, the same graphics are often reused during the formal communication process at or near the conclusion of an investigation. Graphical representations can let nonprofessionals and those with less time on the investigation know what happened. Even though catching the bad guy or reconstructing what happened is the primary role of the fraud examiner or forensic accounting professional, a successful career requires that the investigators be able to communicate their results in both written and verbal form. The challenge for the typical professional in this field is that they understand and embrace numbers; however, the legal world is one of words. Thus, the successful investigator must move from a world of numbers to the less familiar world of words.

Written format includes meticulously developed work papers and evidence binders, written reports, and written presentation materials. Oral reports include interviewing and interrogation skills, summarizing investigation status and outcomes to attorneys, prosecutors, judges, and juries. Graphical tools, such as link charts, flow charts, commodity and money flow diagrams, timelines, and other graphical representations, are both important investigative tools and excellent communication tools. These tools are examined in more detail in the digital forensic accounting chapter. For now, it is important to note that the investigator needs to ground these graphics in the evidence and needs to maintain backup that indicates where the data came from. Software programs including PowerPoint, Excel, and Word offer tools that can be used to create graphical representations of linkages, flows, and timing. More sophisticated software such as Tableau, Visio, and I-2 can also create graphics; when used properly, these resources are able to present complicated material in an easily understandable, graphical representation.

Big Data and Data Analytics

Almost all organizations have computer systems. These systems can capture large amounts of data, which is both a blessing and a curse. While data availability may help to further analysis and detection efforts, if it is not examined using a targeted approach, the professional might not know where to begin—everything looks anomalous or nothing looks anomalous. Data analytics and big data techniques can highlight anomalies—over time, by location, by employee—to detect fraud. Data analysis can point antifraud and forensic accounting professionals in the direction of those most likely to inform the examination. Once suspected, electronic evidence is isolated using big data and data analytics tools, supplemental evidence gathered from a deeper examination of the details can be accumulated to conclusively prove whether the anomalies are explainable, based on the totality of the evidence.

The Importance of the Story Line: Who, What, Where, When, How, and Why

To be successful, the investigator must be able to explain—to prosecutors, attorneys, juries, judges, and other participants in the investigative process—the outcome of the investigation: who, what, when, where and how. Investigations centered on the triangle of fraud action/elements of fraud (the act, concealment, and conversion) have the greatest chances of being successful, assuming that these investigative outcomes are grounded in the evidence.

Although fraud examiners and forensic accountants use evidence-based decision making, critical thinking skills are essential to understanding what the numbers mean. The ability to use nonfinancial information, as well as financial data gathered from the books and records to tell a compelling story, is crucial to success. As these professionals move forward in their investigations, they shift from a world grounded in numbers to one where words carry the day. As such, when fraud examiners or forensic accountants reach the point of drawing conclusions, they must be able to tell a complete story that explains who, what, where, when, how, and, possibly, why. Essentially, they need to communicate like a journalist telling a news story.

Teamwork and Leadership

Thinking like a fraudster may be challenging, so the use of investigative teams can be an effective tool. In cases involving large frauds, for example, investigators should use other professionals to brainstorm, interpret the significance of evidence, develop new fraud theories, and work to connect the dots. Even if the fraud professional is the only one “following the money,” the broader team might include lawyers, managers, paralegals, and other forensic investigators. All play an integral role as team members and should be consulted regularly and kept “in the loop” with any new information.

Being a successful team player requires at least two attributes. First, each team member must be professionally competent at his or her assigned task. For your teammates to be able to rely on your work, they must believe that it will be completed to the highest standards. One of the criteria included in the ACFE code of ethics is that CFEs “at all times, shall exhibit the highest level of integrity in the performance of all professional assignments, and will accept only assignments for which there is reasonable expectation that the assignment will be completed with professional competence.” Professional competence is an essential pillar of successful teamwork. The second major attribute of teamwork is character. Your teammates must be able to count on you as a person. The following gives examples of teamwork attributes that are required for successful completion of fraud and forensic investigations.

COMPETENCE

1. Contributing high-quality ideas
2. Contributing high-quality written work
3. Demonstrating a professional level of responsibility to the team: “get it done”

CHARACTER

1. Attending meetings, prepared and on time with something to contribute
2. Being available to meet with teammates
3. Completing a fair share of the total workload
4. Listening to teammates’ ideas and valuing everyone’s contributions

At a minimum, being a good team participant means being a trusted team member. That allows each teammate to contribute to the overall success of the team. Interestingly, leadership is also important to successful team operations. Leadership not only refers to the person with the assigned role of leader but also to individual team members. Thus, good teammates also demonstrate leadership when their unique abilities are needed by the team.

Predication

Predication is the totality of circumstances that lead a reasonable, professionally trained, and prudent individual to believe that a fraud has occurred, is occurring, and/or will occur. All fraud examinations must be based on proper predication; without it, a fraud examination should not be commenced. An anonymous tip or complaint, as in the Linda Reed Collins example cited earlier, is a common method for uncovering fraud and is generally considered sufficient predication. Mere suspicion, without any underlying circumstantial evidence, is not a sufficient basis for conducting a fraud examination.

Fraud Prevention and Deterrence

Given the cost of fraud, prevention and deterrence are typically more cost beneficial than attempting to remediate a fraud that has already occurred. Fraud prevention refers to creating and maintaining environments in which the risk of a particular fraudulent activity is minimal and opportunity is eliminated, given the inherent cost–benefit trade-off. When fraud is prevented, potential victims avoid the costs associated with detection and investigation.²¹

Fraud deterrence refers to creating environments in which people are discouraged from committing fraud, although it is still possible. The 2016 Federal Sentencing Guidelines Manual defines deterrence as “a clear message sent to society that repeated criminal behavior will aggravate the need for punishment with each recurrence.” Deterrence is usually accomplished through a variety of efforts associated with internal controls and ethics programs that create a workplace of integrity and encourage employees to report potential wrongdoing. Such actions increase the perceived likelihood that an act of fraud will be detected and reported. Fraud deterrence can also be achieved through the use of continuous monitoring/auditing software tools. Fraud deterrence is enhanced when the perception of detection is present and when potential perpetrators recognize that they will be punished when caught.

Fraud Detection and Investigation

Fraud detection refers to the process of discovering the presence or existence of fraud. Fraud detection can be accomplished through the use of well-designed internal controls, supervision, and monitoring and the active search for evidence of potential fraud. Fraud investigation takes place when indicators of fraud, such as missing cash or other evidence, suggest that a fraudulent act has occurred and requires investigation to determine the extent of the losses and the identity of the perpetrator.²²

Remediation: Criminal and Civil Litigation and Internal Controls

Remediation is a three-pronged process: (1) the recovery of losses through insurance, the legal system, or other means; (2) support for the legal process as it tries to resolve the matter in the legal environment; and (3) the modification of operational processes, procedures, and internal controls to minimize the chances of a similar fraud recurring.

We have eight types of assignments for instructors to choose from:

1. Critical Thinking
2. Review Questions
3. Multiple Choice Questions
4. Fraud Casebook
5. Brief Cases
6. Major Case Investigation (MCI)
7. IDEA Exercises
8. Tableau Exercises

Short Answer Questions

1. What type of fraud scheme did Bernie Madoff commit?
2. What was Bernie Madoff’s monthly average return to his clients?
3. How long did this monthly average return last?
4. Describe the demographics of Bernie Madoff’s customer base.
5. How was Madoff’s scheme discovered?
6. Did anyone attempt to inform the regulators about Madoff’s scheme? If so, who?

Discussion Questions

1. In general, would you define Bernie Madoff’s clients as sophisticated investors or naive? Why?
2. Whether you described Bernie Madoff’s customers as naïve or sophisticated, what trait(s) allowed his clients to become victims?
3. Why wasn’t Bernie Madoff’s scheme caught earlier?

Chapter 1 MCI Introduction—Johnsons Real Estate

James Johnson is the broker and owner of Johnson Real Estate, a real estate sales organization in Morgantown, West Virginia. Normally, Johnson hires a local accounting firm on an annual basis to audit the organization’s financial records. With the business in a state of rapid growth, Johnson has been preoccupied and has forgone the audit for the last three years. Instead, his wife, Ashley Johnson, has exercised her somewhat rusty college accounting skills to pull the data needed for tax professionals to prepare the tax returns. In prior year, Ms. Johnson observed no issues with the records.

During the current year’s annual reconciliation of accounts, Ashley discovered discrepancies between the commission receipts from real estate closing records and the actual bank deposits. Ashley also noted that despite assurances from her husband that business has been good, the checking account balance has continued to decline and the company’s bank account fell into the red (a negative number) in December, and the company bounced a few checks during the month. Ashley also noted some unusual expenditures (seemingly nonbusiness-related expenses) in the company accounts that she was not aware of; such expenditures were not observed in prior years.

Ashley Johnson promptly but quietly filed a report with the local prosecutor, a long-time family friend and requested a thorough investigation. As a result, the prosecutor’s office has contracted a regional accounting firm to perform the financial examination.

The assignment includes working with prosecutors, special agents, law enforcement, and the complainant (Ashley Johnson). The accounting firm’s managing partner has stressed the following points:

• The prosecutor’s office has assigned special agents (SA) from the Task Force on White Collar Crime to conduct an investigation. Ashley Johnson will pay all fees for this investigation. If criminal charges are found to be supported, the prosecutor’s office will take the case forward.
• It is extremely difficult to schedule time with the Johnson’s:
  • James Johnson is politically well connected in the community and difficult to contact due to the nature of his business. Also, given his wife’s concerns, he will not be contacted directly.
  • Ashley Johnson is a practicing surgeon at a local hospital.
  • The couple has four children.
• Johnson Real Estate is a “small business” and does not employ staff accountants.
• Last month a fire at the real estate office destroyed the financial records, both paper and electronic.

In addition to compiling questions and information requests for the Johnson meeting, documentation of the team’s working processes and discussions is to be prepared and maintained throughout the course of the case as working papers.

Assignment:

Develop a preliminary examination plan to investigate the issues described in the fact scenario:

1. Consider the various issues outlined above and think critically about how you might approach the examination.
2. Brainstorm the case issues identified and start to generate a series of questions that you, as the investigator, must answer to proceed with the investigation and “solve the case.”
3. Rank order the issues and related questions.
4. Develop a data request that describes the evidentiary material required to proceed with the investigation. The data request lists physical and/or electronic evidence that might be helpful. Recall that as a forensic accountant and fraud examiner that “numbers” are your bailiwick. As such, evidence (data) could be physical or virtual, and examples might include financial numbers, financial documents, statements, invoices, cancelled checks, dates, times, contracts, databases, nonfinancial metrics, etc. Because of the fire at Johnson’s Real Estate, where would you find these records? (Note: The prosecutor has subpoena power to solicit evidence from third-party sources.)
5. What evidence is required to examine the issue or answer the question?
6. Submission to instructor: On 1-page, prioritize your list of issues/questions and associated data request. The submission should be in table format: column 1—issue/question, column 2—data request, column 3—time period, and column 4—purpose of data request. Each row of the table should be a separate issue/question.

Note: Academic cases are simulated and students may not receive all data requested.

TABLEAU EXERCISES

This assignment assumes that the instructor and students have downloaded and opened the academic version of Tableau. As of the time of this writing, the web address of the Tableau Academic Programs is the following: https://www.tableau.com/academic

Professors interested in incorporating Tableau into the classroom may locate this information from Tableau directly.

Tableau Objective. The overall objective of the following assignments is to support, through communication and analysis, a forensic accounting/fraud examination of the payroll records related to contractors for the period January 1, 2018 through June 30, 2019.

Tableau case background: See IDEA case background.