Chapter 14: Fraud Against Organizations
I. General statistics – Theft by employees – 2006 & 2008 Report to the Nation-
Percent Median Loss
A. Gender 2006 2008 2006 2008
1. Male 61 59 $250,000 $250,000
2. Female 39 41 $102,000 $110,000
1. Over 60 2.8 3.9 $713,000 $435,000
2. 51-60 15.3 18.9 $350,000 $500,000
3. 41-50 35.0 35.5 $250,000 $250,000
4. 36-40 16.0 16.2 $135,000 $145,000
5. 31-35 16.0 12.8 $134,000 $113,000
1. Postgraduate 12.2 10.9 $425,000 $550,000
2. Bachelor 33.4 34.4 $200,000 $210,000
3. Some College 21.6 20.8 $200,000 $196,000
4. High School 32.8 33.9 $100,000 $100,000
D. Occupational Fraud
1. Asset Misappr.91.5 88.7 $150,000 $150,000
2. Corruption 30.8 27.4 $538,000 $375,000
3. F/S Fraud 10.6 10.3 $2,000,000 $2,000,000
E. Asset Misappr.
1. Cash 87.7 $150,000
2. Non-cash 23.4 $200,000
3. Skimming 18.9 $76,000
4. Larceny 14.2 $73,000
F. Corruption % of corruption cases
1. Bribery 42.7
2. Conflict of Int 61.6
3. Extortion 16.9
4. Ilegal Grat. 29.8
G. Other – All cases
1. Median loss $159,000 $175,000
2. Loss of revenues 5% 7%
3. Duration – Months 18 24
Tip 44% 46%
II. Asset Misappropriations – Theft or misuse of assets
A. Three opportunities to steal –Slide 5
1. Cash or other assets as they come into organization
2. Cash, inventory and other assets on hand
3. Disbursement fraud – having org. pay for something it should not
pay or pay too much.
1. Larceny-theft of cash after it has been recorded
2. Skimming- theft of cash prior to recording
C. Fraudulent disbursements
1. Check tampering
2. Register disbursement schemes
a. False refunds
b. False voids
3. Billing schemes
4. Expense schemes
a. Mischaracterizing expenses
b. Overstating expenses
c. Submitting fictitious expenses
d. Submitting same expenses multiple times
5. Payroll schemes
a. Ghost employees
b. Falsified hours and salary
c. Commission schemes
d. False workers’ compensation claims
D. Theft of inventory and other assets
1. Misuse of assets
2. Assets stolen
III. Corruption – Slides 8 & 9
B. Conflicts of interest
1. Purchase schemes
2. Sales schemes
C. Economic extortion schemes
D. Illegal gratuity schemes
Chapter 16: Bankruptcy, Divorce, and Tax Fraud
I. Tax Fraud
A. Definition – intentional underpayment of taxes – includes not reporting
income, deliberately overstating tax deductions and exemptions.
B. Penalties - line between negligence and fraud is not always clear.
1. Mistakes – 20% penalty
2. Fraud – 75% penalty
C. Audit of return
1. May assess civil fines and penalties or
2. Refer your case to IRS Criminal Investigation (CI) Division (arm
of IRS that investigates tax fraud).
D. Criminal Investigation Division – Tax and money laundering crimes
1. Combines accounting and law enforcement skills.
2. Trained to follow the flow of the money.
3. Trained to conduct complex financial investigations.
4. Conviction rate – 98%.
5. Individual taxpayers commit 75% of the tax frauds-mostly
middle income earners. Corporations make up most of the rest
6. Most common tax fraud – underreporting income. Committed
mostly by self-employed people who work in restaurants, clothing
store owners, car dealers, etc.
7. To be a special CI agent – must be a US citizen and not over 37
years old. Must have 15 hours of accounting.
E. Tax evasion –Willfully evading tax or willfully failing to pay a tax,
making false statements on any return, or aiding in the preparation of
fraudulent tax returns. The following sentence and penalties can be
assessed (in addition to interest and penalties on the interest from the due
date of the return to the payment date): IRC section 7201
1. Imprisonment up to five years.
2. Fine of up to $250,000.
3. Civil fraud penalty of 75% on the portion of the underpayment due
4. Costs of prosecution
F. Statute of limitations
1. IRC section 6531-generally a person cannot be tried or punished
unless indicted within three years of the offense.
2. The willful attempt to evade taxes extends the statute of limitations
to six years. The six year period begins from the last tax evasion
act and could be as later than the due date of the tax return.
II. Divorce Fraud
1. Divorce fraud – intimidation, concealment, deceit, or breach of
2. More than 1 million divorce cases are filed annually.
3. Approximately 50% of all marriages fail
4. Divorces generally result in hostility between the spouses
5. People involved in divorce cases are required to supply each other
and the court with complete financial statements.
B. Three Categories
1. Fraud causes the divorce
2. Divorce is used to perpetrate the fraud
3. Divorce is used to conceal the fraud
C. Most divorce litigation result from two factors
1. Plaintiff spouse alleges defendant hid assets from divorce court.
2. The values assigned to asset were unrealistically low-resulting in
unfair divorce settlement.
D. The most common area of fraud connected with divorce is asset
concealment. Red flags that assets might be concealed:
1. Transfers of property or large payments to related parties or
individuals, such as relatives.
2. Frequent and unusual transfers between bank accounts, particularly
overseas and business and personal accounts.
3. Unusually large payments to particular persons that are not
4. Unusual or rapid reductions in assets.
5. Inconsistencies between tax returns and the official forms filed in
the divorce court.
6. Travel to off-shore tax havens or locations that allow secret bank
7. Missing, inaccurate, or damaged records.
III. Bankruptcy Fraud
A. Majority of bankruptcies come in the form of complete liquidations
B. Most common schemes- concealment of a debtor’s assets (70% of
bankruptcy fraud) and bust-outs. Petition mills and multiple filings next
most frequent schemes. More than 10% of bankruptcy cases involve bankruptcy
C. Purposes of filing – Slide 5
1. Gives debtor relief from creditor collection and foreclosure
2. Protects creditor from unfair collection efforts by other creditors
3. Allows debtor to work out an orderly plan to settle debts or
liquidate assets and distribute the proceeds to creditors in a way
that treats creditors equitably.
D. Bankruptcy code
1. Title 11 – refer to as the bankruptcy code. Governs the bankruptcy
process and provides for several types of bankruptcy.
a. Chapters 1, 2 and 5 – general provisions that apply to all
b. Chapters 7 and 11 apply to corporations and individuals
c. Chapter 7 – complete liquidation, shutting down of the business.
Completely discharges debtor from all debt with no obligation to
make payment from future income.
d. Chapter 11 – Creditors are told to back-off and business is
allowed to operate in a reorganized fashion
e. Chapter 13 – reorganizations that can be used by individuals
whose income is too large to permit them to file under Chapter 7.
Debtors are required to make specific payments to creditors for a
specific number of years.
f. If Chapters 11 and 13 don’t work, judge can order a Chapter 7
2. Civil and Criminal bankruptcy fraud statutes
a. Criminal – Prosecuted by US Attorney’s office in applicable US
b. Civil – Conducted in US Bankruptcy Court.
3. Bankruptcy fraud penalties- Maximum of 5 years in prison and
maximum fine of $250,000 or both per offense.
E. Concealment of Assets
1. Title 18, Section 152 – crime to knowingly and fraudulently
conceal property of a debtor’s estate or falsify any documents,
records or statements.
2. Means of concealing assets, page 581 – Slide 6
1. Red flags of concealment
B. Fraud Investigator’s Relationship
1. Allows trustees to employ, with approval of court, attorneys,
2. Allows a creditors’ committee to employ attorneys, accountants,
3. In order to be compensated from estate funds, must be employed
under Code Section 327 and approved by the bankruptcy judge.
IV. Money Laundering
A. Nature – Process by which one conceals the existence, illegal source, or
illegal application of income and then disguises that income to make it
B. Who are the criminals?-drug traffickers, embezzlers, corrupt politicians
and public officials, mobsters, terrorists, and con artists.
C. Money laundering process: See Figure 16.1 and Slide 10
D. Combating Money Laundering – Financial Action Task Force (FATF)
E. Red Flags of Money Laundering- Page 584.
Chapter 17: Fraud in E-Commerce
I. E-commerce opportunity elements that create increased risks –Slide 4
A. New technologies for which security developments often lag transaction
B. Complex information systems make installing controls difficult
C. Transfer of large amounts of information poses theft and identity risks
D. Removal of personal contact allowing for impersonation or falsifying
E. Lack of physical facilities that facilitates falsifying websites and business
F. Electronic transfer of funds allows large frauds to be committed more
G. Compromised privacy often resulting in use of stolen or falsified
II. E-commerce risks inside of organization – Slide 6
A. Abuse of power granted to users-programmers and technical support
personnel often have supervisor access to system they create and administer.
B. Data theft-personal information about customers can be sold or misused.
C. Passwords-left to end user and cannot be controlled (Social
D. Sniffing (viewing of information that passes along network line)- Used to
gather information from unencrypted communications.
E. Laptops-may be used to bypass firewalls and controls. Employees walk
laptops from unprotected networks to protected networks.
F. USB drives and portable external hard drives-can download significant
amounts of information from internal networks.
III. E-commerce risks outside of organization- Slide 7
A. Internet enables hackers to gain access to personal systems
1. Cross international boundaries and are mostly anonymous
2. Tracing and prosecution very difficult
3. If caught-sentences are light
B. Phishing-e-mail or pop-up messages asking for personal information.
Example- Impersonates technical support for employees
A. False websites- Used to trick users to provide personal information.
B. Spoofing-hides identities by changing information in the header. Forges
C. Falsified identity – pretending to be someone you’re not.
IV. Preventing e-commerce fraud- security measures should be based on time-tested
methods that are mathematically sound. Slide 8
A. Security through obscurity should never be an option.
B. Should use virtual provate networks, firewalls, public & private key
infrastructure, SSL encryption, etc.
V. Internal controls in e-business
A. Control environment
1. Integrity and ethical values
2. Participation by board of directors and audit committee
3. Management philosophy
4. Human resource policies and practices.
B. Risk assessment- identifies key risks for electronic exchange of
information and money.
C. Control activities
1. Separation of duties
2. Proper authorization of transactions
3. Adequate documents and records
4. Physical control over asset and records
5. Independent checks on performance
VI. Detecting fraud in e-business – Slides 9 & 10
A. Understand the business or operations of the organization
B. Identify what frauds can occur
C. Determine the symptom that frauds would generate
D. Use databases and information systems to search fro symptoms
E. Follow up on symptoms- what causes these symptoms.
VII. Other Preventive Measurers
A. Regular audits of user behavior
B. Train employees on what e-commerce fraud looks like
C. Use employee tip lines
C. Internet worms
F. Trojan horse
J. Social engineering
Chapter 18: Legal Follow-up
I. Court system
A. State courts – Slide 4
1. State and local courts generally handle fraud cases.
2. Lower-level trial courts- Initial actions are heard for
misdemeanors and pretrial issues for felony and civil
cases that are below $10,000. There is no jury trial in
probate, family law, estate issues and equitable issues.
3. Higher-level trial courts-Initial actions for felonies and
cases of more than $10,000.
4. Intermediate appellate or reviewing court- 3 judges per
5. Higher level Appellate-5 to 9 judges- final level
B. Federal courts – Slides 5 & 6
1. Frauds are tried in tax court (tax fraud), bankruptcy courts
(bankruptcy fraud), and US district courts (mail frauds, etc.)
2. Hear fraud cases that involve federal laws or include several states.
The controversy must exceed $50,000.
3. U.S. Court of Appeals-Hears appeal of judgments rendered in
4. Supreme Court- Reviews decisions made by Courts of Appeals in
the 12 circuits.
II. Criminal law
A. Prosecution either federally or by a state for violating a statute that
B. May serve jail sentences, pay fines and make restitution to victims.
C. Must be proven guilty beyond a reasonable doubt.
D. Juries must rule unanimously on guilt.
E. Provides more protection for rights of the defendant than does civil law.
1. Fourth Amendment –Protects defendants against unreasonable
searches and seizures by the government.
2. Fifth Amendment- provides the right to refuse to incriminate
3. Sixth Amendment- relates only to trials.
F. The criminal litigation process – Slide 9
1. Filing criminal charges
2. Arresting and charging the defendant
3. Preliminary hearings
6. Pretrial motions
7. Trial and appeal
G. Preliminary hearings vs. grand jury, pp 630-631
1. Preliminary hearing – Used to determine whether “probable
Cause” exists to charge defendant with a crime. Held before a
judge and hearsay and illegally obtained evidence can be heard.
Defendant is represented by an attorney who can cross-examine
2. Grand jury – Prosecution generally prefers to obtain a grand jury
indictment. Consist of 16-23 people. Can consider any evidence,
even that which would not be admissible at trial. Defendants do not
have a right to be notified that a grand jury is considering evidence
against them. Defendants are not allowed to review the evidence,
confront their accuser, or present evidence in their defense. They
cannot be accompanied by their attorneys. The Sixth Amendment
protections are denied during the grand jury process.
III. Civil law
A. Provides remedies for violations of private rights
B. Purpose- to compensate for harm done to individual or organization.
C. May use a few as 6 jurors.
D. Verdict need not be unanimous.
E. Often heard by judges instead of juries.
F. Prove case by the “Preponderance of the evidence.”
IV. Civil litigation process – four steps – Slide 8
A. Investigation and pleadings
C. Motion practice and negotiation
D. Trial and appeal
V. Litigation services provided by accountants
A. Consultant- Hired by an attorney to gather and interpret facts, prepare
analyses, help interpret evidence, advise about issues and strategies
involved in a legal matter, locate other accountants to act as consultants or
expert witnesses, and help expert witnesses form their opinions. A
consultant is immune from discovery.
B. Masters and special masters-appointed by the court to assist the court in
some matter-determine certain facts or compute damages. Special master-
appointed by the court to act as the court’s representative. Compensation
is set by the court.
C. Expert witness –retained by an attorney or court as an expert to testify in a
judicial or administrative proceeding. – Slide 10
1. Can offer opinions based on experience, education, or training
about the fraud. A fact or character witness cannot offer opinions but can
only testify as to facts.
2. Fraud expert must qualify as expert witness (voir dire)
3. May testify about- nature of the fraud, the damages suffered in the
fraud, the negligence of the victim in allowing the fraud to happen,
standards (auditing or accounting) that were violated, etc.
4. Deposition of the expert
a. What are the expert’s opinions?
b. Determine the credentials and experience of the expert.
c. Identify evidence that can be used to impeach the expert or
discredit testimony during the trial.
d. Assess how difficult the expert will be in the case.
5. Do’s and Don’ts at deposition, trial, and cross-examination, Page
6. Accountants hired to testify as an expert may not use the attorney-
client privilege. However, a non-testifying expert may fall under an
attorney work product privilege.
D. Written Agreement – Accountants asked to perform litigation services should
enter into a written agreement with the employing attorney. Items covered by the
written agreement should include:
1. Name of the attorney client
2. Litigants’ name and place of the legal proceeding
3. Nature of the litigation services to be performed
4. Whether accountant will be asked to testify as an expert witness
5. Restriction imposed on use and disclosure of practitioner’s work
6. Any conflicts of interest with the litigants or attorneys
7. Whether accountant will be protected by the attorney work product
8. Circumstances for termination