Fraud Examination

A fraud examination is the process of addressing allegations of fraud from beginning to disposition and is a primary responsibility of anti-fraud specialists. These examinations, which may include looking into allegations of fraud or reviewing an organization's anti-fraud policies, are critical to a fraud examiner's understanding.

The purpose of these examinations is to identify the perpetrators and ascertain the nature of the fraud. There may also be special engagements or extra goals, such as obtaining evidence for legal or disciplinary actions or presenting documentation for recovering damages. Regular checks help prevent organizations from getting into legal trouble and ensure compliance with standards.

Fraud examination is a systematic process for resolving fraud allegations from inception to disposition, establishing a uniform legal process. The purpose of this examination is to resolve charges of fraud by evaluating whether fraud occurred and who perpetrated it. It also works with them to present facts that can be used in court proceedings or to recover fraud losses. The examination moves in a linear order, investigating from general to specific issues in accounting standards and practices followed. It then gradually focuses on the perpetrator through evidence analysis, ensuring timely resolution of fraud signs or allegations. Accountants and non-accountants can both conduct these examinations.

Examinations of fraud are critical for organizations to identify inappropriate behavior, identify those accountable, stop fraud, and communicate a solid anti-fraud stance. The process also helps to determine potential liabilities or damages, promote recovery, prevent losses in the future, mitigate consequences, and strengthen the weaknesses in their internal controls.

The examinations may sometimes be mandated by legislation, such as statutes, rules, contracts, or standard law requirements. Directors and executives of a business have a common law duty of care to their organization and its shareholders, and employers may be held liable for investigating employee complaints of retaliation, unfair treatment, or harassment. These evaluations assist firms in gaining a full awareness of potential vulnerabilities and strengthening internal control shortcomings.

An effective financial fraud examination follows the following principles of investigation, and they are as follows:

• Receiving Fraud Reports: Set up robust mechanisms for receiving fraud reports, ensuring confidentiality throughout the process. Documenting investigations meticulously, maintaining a clear log of allegations received, and effectively tracking and managing cases are integral aspects.
• Thorough Investigations: Conduct thorough investigations to gather substantial evidence involving relevant parties, such as internal departments or external auditors. Carefully assess whether the alleged acts contravene laws, rules, or company policies and consider potential disclosure obligations to pertinent parties.
• Punishing Perpetrators: Upon completion of investigations, the examiner shall document fraud examination findings, report them to the overseeing party, and retain reports for future reference. Swiftly implement appropriate disciplinary actions against perpetrators, including termination of employment or legal actions to recover misappropriated assets.
• Remediating Weaknesses: Identify root causes of fraud incidents and implement corrective measures to address control, policy, and procedural weaknesses. Strengthen internal controls, enhance monitoring mechanisms, and provide comprehensive training programs to employees to mitigate future fraud risks.

The examination of fraud involves the following steps in general:

• Observation: In a fraud examination, close attention is paid to a company's operations, processes, and financial activities. The examiner looks for unusual behaviors, inconsistencies, or signs that could signal potential fraud, serving as initial indicators for further investigation.
• Physical Evidence Collection (Document Examination and Computer Forensics): A critical aspect involves gathering and scrutinizing physical evidence. This includes analyzing documents like financial statements, bank records, company invoices, and contracts for discrepancies or false information. Computer forensic examinations are conducted to scrutinize digital evidence, such as emails and system logs, revealing fraudulent activities and hidden information.
• Interviewing: Interviews are pivotal for gathering information, obtaining statements, and identifying suspects or witnesses. By interviewing employees and management, the examiner aims to uncover additional evidence, understand the internal control environment, and gain insights into the fraudulent scheme, using effective techniques to elicit accurate information.
• Evidence Analysis: Examining collected evidence, both physical and digital, is essential. Through meticulous review and analysis, patterns, anomalies, or inconsistencies are identified using various data analysis techniques and forensic accounting methods. This process helps detect irregularities, check transactions, trace funds, and understand the fraudsters' motives, means, and methods.
• Findings Documentation and Loss Quantification: After analyzing the evidence, the examiner shall document fraud examination findings comprehensively. Reports outline identified fraudulent activities, individuals involved, methodologies, and the impact on the organization, often quantifying financial losses. Clear documentation is crucial for presenting the case to management, legal authorities, or other involved stakeholders.

Let us look into a few examples to understand the concept better.

Example #1

Consider the hypothetical example of Danny, a person who has the CFE (Certified Fraud Examiner) designation and could conduct a certified fraud examination.

Danny is a fraud examiner who conducts thorough company fraud examinations. He was asked to render his services to ABC Ltd. Accordingly, he conducts observations of the company's operations, financial records, and business practices to identify potential irregularities. He collects tangible evidence through examining documents and computer forensic examinations, such as financial statements, invoices, receipts, and bank records. Danny also conducts interviews with employees, stakeholders, and witnesses to gather information about suspected fraudulent activities.

Danny then uses various analytical techniques to analyze the collected evidence, detecting patterns, anomalies, and inconsistencies. He uses data analysis tools and forensic accounting methods to examine financial records, identify hidden assets, trace funds, and determine the extent of the fraud.

After a thorough examination, Danny documents his findings, including the identified fraudulent activities, individuals involved, the company's impact, and the quantification of financial losses. Through a certified fraud examination, he prepared detailed reports that highlight the evidence, methodologies used, and recommendations for further actions, such as legal proceedings or internal control improvements.

Example #2

A real-life example of a study done that identifies the financial fraud committed by Enron Corp. between 1997-2001 and how it could have been prevented. The company engaged in buying natural gas at high discounts and selling it to wholesale customers, establishing itself as a market leader in the US natural gas market. However, regulations imposed by the Reagan administration led to a shrinking profit margin in 1993. Enron diversified into other sectors, investing billions to replicate its success in natural gas. However, the company's poor management and greed impaired its financial position. Enron borrowed $30 billion to manage costs without damaging its reputation. However, this knowledge was never made public. The investors in the company had no notion that the company was rapidly losing money and no control over mounting losses.

The study concludes that Enron's fraud could have been detected between 1999 and 2000 using analytical tools and has practical implications for auditors, SEC investigators, and other regulatory entities.