CFE Exam Quiz 09

By its nature, fraud examination is a law-intensive field. Legal issues related to fraud are often complex, and their interpretation might require professional legal assistance. The Certified Fraud Examiner always should consult with legal advisors if legal questions arise during a fraud examination. Even with the availability of legal guidance, however, a fraud examiner should be familiar with certain aspects of the law. Often, the success of an investigation hinges on the fraud examiner following the proper legal procedures, whether dealing with a suspect’s rights, collecting documents, or interviewing witnesses. Both the structure and substance of the legal system in each jurisdiction can vary significantly, and so legal issues that arise in fraud examinations will also be different from place to place. The materials in the Law section of the Fraud Examiners Manual are designed to explain the common types of legal systems and approaches to fraud-related issues. White-collar crime often crosses jurisdictional borders, and so fraud examiners should be familiar with their home jurisdiction’s legal processes, as well as have a basic understanding of the systems that they might encounter in foreign jurisdictions. There are different types of law that are determinative to the outcome of legal disputes. The main types include constitutional law, statutory law, common law, administrative law, and international law.

The U.S. Constitution and its accompanying amendments are the foundation of the legal system in the United States. The Constitution defines and limits the powers of the various branches of the government and guarantees basic rights to all citizens—rights such as equal protection under the law, due process, and the right to be free from unreasonable searches and seizures. The Constitution is the supreme law of the land. The legislature may not properly pass, the executive branch may not enforce, nor may the judiciary uphold, any law or action that violates the provisions of the Constitution. There are special processes by which the federal legislature and a supermajority of the states can amend the Constitution, but they may not
violate it.

The Canadian Constitution outlines Canada’s system of government, provides the fundamental rules and principles that govern Canada, and sets out the civil rights of all individuals in Canada. The Canadian Constitution protects individuals from certain actions, and some of the most relevant protections individuals may receive are set out in the Canadian Charter of Rights and Freedoms (Canadian Charter), which is part of the country’s Constitution. Among other things, the Canadian Charter guarantees everyone in Canada certain civil rights regarding the policies and actions of the government. For instance, the Canadian Charter guarantees the right against self-incrimination, which provides that a suspect or an accused person has the right to remain silent both at the investigative stage and at the trial stage of counsel to individuals under arrest and detention. Additionally, section eight protects all individuals from unreasonable search and seizure.

Substantive law defines the type of conduct permissible and the penalties for violation; it is composed of the basic laws of rights and duties. When people say an act is “against the law,” they are referring to substantive law. Substantive law can be further subdivided into public and private law. Public law governs the relationship between individuals and the state; it involves such areas as constitutional law, administrative law, and criminal law. Private law encompasses those areas where the legal system is used to resolve disputes between private parties. Examples of private laws are the laws concerning real property, contracts, civil wrongs (e.g., negligence), wills and estates, intellectual property, business organization law, and so on. Procedural law defines the rules by which individual cases are decided; it sets out the rules of the legal system, including the procedures to be followed in hearing a grievance. Procedural law might include deadlines, filing requirements, steps to follow in bringing a claim, rules of evidence, and so on. Substantive law sets the terms of any dispute; procedural law dictates how a legal dispute is handled.

The most fundamental element to understanding a particular jurisdiction’s legal system is to identify the structure of its government. To know the laws that apply to a case, it is necessary o determine the system of government in the relevant jurisdictions. For example, suppose that a person in Montreal, Canada, has engaged in questionable banking transactions. Which laws would determine whether the conduct was fraudulent—the laws of the Canadian federal government, the laws of the provincial government of Quebec, local laws, or a combination? Additionally, what sources of law apply to determine the suspect’s rights regarding a potential investigation? Understanding the system of government can help answer these questions. There are various ways to classify systems of government, but one of the most helpful for understanding the laws of a particular jurisdiction is whether the system uses a federal or unitary power structure. Moreover, almost every modern-day government can be classified as being either unitary or federal in nature. The majority of countries are unitary systems, meaning that a central government holds all governmental power within the nation. This central government may delegate power to created agencies and regional governments, but it remains the supreme governmental authority in the country. While delegated powers might include law-making authority, substantive laws regarding criminal misconduct, including most fraudulent acts, are typically directly legislated by the central government.

In most common law systems, there are laws that judges develop through court decisions (called the common law), as well as codes and statutes that establish laws. As opposed to legislative statutes, the common law is developed on a case-by-case basis. Again, the common law is a system of legal principles developed by judges through decisions made in courts. It consists of the usages and customs of society as interpreted by the judiciary, and it is often referred to as judge-made law. Common law originated as a legal system in England, and some of the principles established hundreds of years ago in court decisions remain influential to contemporary legal issues. Today, common law systems exist in the United Kingdom, the United States, India, Australia, and many other countries that were once part of the British Empire or were influenced by such legal systems. In common law countries, there are two sources of substantive law: statutory law and common law. Again, statutory law includes statutes passed by legislatures (and regulations passed by administrative bodies). In the modern era of law, the trend in common law countries has been to move away from rules that originate in common law and instead rely on statutory law—laws created by a legislature or other governing authority—as the basis of a dispute. For instance, almost all substantive federal laws in the United States are based on statutes or the U.S. Constitution. However, an additional feature of the common law system that remains important is the precedential value of court decisions. Due to the ambiguity or incompleteness of statutes, legal disputes often arise in which parties support competing interpretations of the law. To decide disputes in common law systems, judges analyze prior cases with similar circumstances and apply the basic principles set forth in those cases to the problem at hand.s

In contrast to common law systems, civil law systems apply laws from an accepted set of codified principles or compiled statutes. Individual cases are then decided in accordance with these basic tenets. Under a civil law system, the judges or judicial administrators are bound only by the civil code and not by the previous decisions of other courts. In deciding legal issues, a civil law judge applies the various codified principles to each case. However, lacunae—gaps in the law—are sometimes present, and judges may seek to fill in such gaps by looking to other authorities or similar laws, including judicial decisions. Civil law and common law systems may exist within the same country. For example, in Canada, the legal system in the province of Quebec is not based on the British tradition of common law (as in the other provinces); instead, it is more influenced by the French and Roman civil law systems.

Adversarial processes are those in which the parties to a proceeding drive the discovery process (the search for evidence). The theory behind this approach is that the competing interests of the parties will serve to expose the relevant facts of the case. In adversarial systems, the parties to the litigation gather and present the evidence to the court. For example, the parties (usually through a legal counsel) conduct questioning of fact and expert witnesses. The fact-finder of the court, which can be a judge, jury, or administrator, is unaware of the details of the case until the parties present evidence. Judges facilitate the production of evidence between the parties, but generally, do not seek evidence on the court’s behalf. One of the distinct features of the adversarial process is its approach to criminal procedure, where the rights of defendants are of paramount concern. Most adversarial court systems do not require defendants to testify. Also, defendants are given the presumption of innocence, which puts the burden of proof on the government to prove the criminal accusations.

An inquisitorial process refers to a fact-finding approach that places the primary responsibility of discovering evidence on the presiding judge. In an inquisitorial process, the primary goal is to find the truth. Rather than serving as a referee over the parties’ production of evidence, the judge is actively involved in the discovery. For instance, judges may request relevant documents on their own accord and ask factual questions of witnesses themselves. As a result, attorneys play a smaller role in the evidentiary process than in an adversarial process. Criminal rights are generally less emphasized in inquisitorial trials than in adversarial systems; the former system focuses on getting to the truth of the matter. One of the most significant departures from the adversarial process is that defendants in criminal inquisitorial proceedings may be called to testify (whereas in adversarial systems, the defendant may testify, but does not have to do so). Note that civil (as opposed to criminal) proceedings under both adversarial and inquisitorial processes typically allow the defendant to be called to testify.

Which court has jurisdiction over an issue could depend on several factors, such as a party’s presence in the jurisdiction where the court is located. A similar issue is that courts must choose which jurisdiction’s laws to apply to each issue in a case. Problems arise because the outcome of a case might depend on which jurisdiction’s laws are applied. In other words, conduct that is fraudulent in one jurisdiction might be legal, carry different penalties, or result in different remedies in another jurisdiction. In terms of procedural law, almost every court applies the procedural rules of its own jurisdiction (which includes choice-of-law rules). However, the way that courts choose substantive law is less consistent. Generally, most courts consider some mix of the following factors to determine which jurisdiction’s laws apply:
• The nationality of the parties to the litigation
• The current residence of the parties (whether temporary or permanent)
• The parties’ current or past physical presence in the relevant jurisdictions
• The jurisdiction where the transaction or underlying cause of action occurred

After a fraud is discovered, fraud examiners might need to assist in making a recommendation concerning the recovery of lost assets. In cases involving suspects in foreign jurisdictions, this task can be complicated by the ability to obtain and enforce a judgment against a particular defendant. For instance, a domestic judgment against a foreign defendant is usually helpful for recovering the defendant’s assets located in the domestic country, but might be worthless for obtaining the defendant’s assets in a foreign country. Some, but not all, countries enforce foreign judgments concerning parties or assets within their jurisdiction. Whether the country will enforce a foreign court’s judgment usually depends on the circumstances in which the internal laws of the jurisdiction recognize foreign judgments and whether the two countries of each court have an enforcement treaty. Alternatively, a fraud victim could seek to obtain a judgment against a foreign suspect in the suspect’s home country. The cost and feasibility of this endeavor can vary widely. Therefore, whether an enforcement action against a foreign defendant is sought is a legal issue, and fraud examiners should consult legal counsel in making a recommendation.

Countries have different types of court systems. Many courts follow a tiered court system in which there are trial courts and appellate courts. In such systems, the trial court conducts the trial and issues a judgment. Then, the lower level appellate courts review the trial court’s rulings and procedures and issue a decision. The lower level appellate court’s ruling is then Courts is defined by their jurisdiction and venue. Jurisdiction is the power of a court to hear authority may be exercised by a court. For instance, a country might have a system of probate courts that only have jurisdiction to hear cases whose subject matter is related to wills, inheritance, and other probate matters. Some countries have low-level trial courts that jurisdiction is defined by the parties that it may hear a case about. For example, courts usually, do not have jurisdiction over foreign parties who have never been to and have had no business or presence in the court’s jurisdiction. Venue refers to the geographical area covered by the court; it is the physical location where the lawsuit is to be tried. Venue is technically an element of the court’s jurisdiction. This issue may be important in deciding where to file charges or claims.

A criminal action is a complaint brought by the government, acting on behalf of citizens and the interest of the jurisdiction, against a person accused of violating a law. Increasingly, most criminal offenses are codified in statutes or regulations. Typically, to be guilty of a crime, a defendant must be found to have committed an offending act (called the actus reus) and to have the requisite culpable mental state when he committed the act (called the mens rea). The actus reus may involve the full act of committing a crime or merely the initial steps for crimes of attempt. Different offenses require different levels of men’s rea, such as actual intent, recklessness, or, in some circumstances, no more gross negligence. Some criminal offenses, however, are strict liability offenses, which are offenses in which the government does not have to prove the defendant’s intent. Criminal cases are punished by outcomes such as imprisonment, fines, orders of restitution, probation, and community service.

The specific elements of proof required to establish a misrepresentation claim vary somewhat according to where the fraud occurred and whether the case is brought as a criminal or civil action, but the elements normally include:
• The defendant made a false statement (i.e., a misrepresentation of fact).
• The false statement was material (i.e., the statement was sufficiently important or relevant
to influence the making of a decision).
• The defendant knew the representation was false.
• The victim relied on the misrepresentation.
• The victim suffered damages as a result of the misrepresentation.

Although a misrepresentation fraud case may not be based on negligent or accidental misrepresentations, in some instances, civil liability may arise from negligent misrepresentation. Negligent misrepresentation occurs in situations where there is a special relationship that imposes a duty on the defendant to provide correct information to the plaintiff. Generally, the specific elements required to establish a negligent misrepresentation claim are as follows:
• The defendant made a misrepresentation of a material fact.
• The misrepresentation was made pursuant to a special relationship that imposed a duty
on the defendant to provide correct information.
• The defendant had no reasonable basis to believe the misrepresentation to be true.
• The victim relied on the misrepresentation, and the reliance was reasonable.
• The victim suffered damages as a result

The elements of commercial bribery vary by jurisdiction, but typically include:
1. The defendant gave or received a thing of value.
2. The defendant acted with corrupt intent.
3. The defendant’s scheme was designed to influence the recipient’s action in a business decision.
4. The defendant acted without the victim’s knowledge or consent.

Illegal gratuities are items of value given to reward a decision, often after the recipient has made the decision. Illegal gratuities are similar to official bribery schemes, and most illegal gratuity laws outlaw gratuities in the public sector. In general, the elements of an illegal gratuity are:
1.A thing of value
2.Given, offered, or promised to (or demanded, sought, received, or accepted by)
3.A (present, former, or future) public official
4.For or because of any official act performed or to be performed by such public official

A conflict of interest occurs when an employee or agent—someone who is authorized to act on behalf of a principal—has an undisclosed personal or economic interest in a matter that could influence his professional role. It encompasses a conflict between the professional duties and the private interest of an employee or agent, in which the employee or agent’sprivate interest could improperly influence the performance of his professional duties and responsibilities. Conflicts of interest involve a state of opposition between an individual’s personal and professional interests, and they can occur in various ways. For example, a conflict may occur when a procurement employee accepts inappropriate gifts, favors, or kickbacks from vendors, or when an employee engages in unapproved employment discussions with current or prospective contractors or suppliers. Statutes (in some cases) or common law prohibit people from engaging in conduct that involves a conflict of interest. Elements of a typical civil claim for conflict of interest include:
1. The defendant is an agent of a principal or employer.
2. The agent takes an interest in a transaction. Law The Law Related to Fraud
2017 Fraud Examiners Manual (International) 2.209
3. The agent’s interest is actually or potentially adverse to the principal (i.e., the interest is
one that could cause the agent or employee to place his personal interests ahead of the
principal or employer).
4. The agent did not disclose the interest and obtain approval by the principal.

Embezzlement is the wrongful appropriation of money or property by a person to whom it has been lawfully entrusted (or to whom lawful possession was given). Embezzlement involves a breach of trust, although it is not necessary to show a fiduciary relationship—a relationship of confidence, trust, or good faith—between the parties. The elements of embezzlement vary somewhat by jurisdiction, but generally, are
1. The defendant took or converted
2. Without the knowledge or consent of the owner
3. Money or property of another
4. That was entrusted to the defendant (the defendant had lawful possession of the property)

Larceny is defined as the wrongful taking of money or property of another with the intent to convert or to deprive the owner of its possession and use. Unlike in embezzlement schemes, in larceny, the defendant never has lawful possession of the property. The elements of larceny typically include:
1. Unlawfully taking or carrying away
2. Money or property of another
3. Without the consent of the owner
4. With the intent to permanently deprive the owner of its use or possession

The definition of what constitutes a trade secret depends on the organization, industry, and jurisdiction, but the following three characteristics are common to most definitions:
1. The information is not generally known to the relevant portion of the public.
2. The information confers some sort of economic benefit on its holder (where this benefit must derive specifically from it’s not being generally known, not just from the value of the information itself).
3. The information is the subject of reasonable efforts to maintain its secrecy.

The elements of a typical claim for misappropriation of trade secrets are:
1. The defendant possessed information of value.
2. The information was treated confidentially.
3. The defendant took or used the information by breach of an agreement, confidential relationship, or other improper means.

Generally, a nondisclosure agreement is a written agreement providing that signatory employees must keep all trade secrets and proprietary information learned during their employment confidential. Nondisclosure agreements serve the following functions:
1. They delineate the confidentiality expectations the employer has for its employees.
2. They demonstrate that the employer is serious about protecting trade secrets and proprietary information.
3. They show the reasonable efforts that the employer takes to maintain the secrecy of its confidential information

Official bribery refers to the corruption of a public official to influence an official act of government. Illegal payments to public officials can be prosecuted as official bribery, and they can give rise to stiff penalties. The elements of official bribery vary by jurisdiction, but generally include:
1. The defendant gave or received (offered or solicited) a thing of value.
2. The recipient was (or was selected to be) a public official.
3. The defendant acted with corrupt intent.
4. The defendant’s scheme was designed to influence an official act or duty of the recipient.

The duty of loyalty requires that the employee/agent act solely in the best interest of the employer/principal, free of any self-dealing, conflicts of interest, or other abuse of the principal for personal advantage. Employees/agents who owe a duty of loyalty must act solely in the best interest of their principal and may not seek to advance their personal interests to the detriment of their principal. Accordingly, corporate directors, officers, and employees are barred from using corporate property or assets for their personal pursuits or taking corporate opportunities for themselves. Additionally, if an employee/agent commits a more traditional form of fraudulent conduct, such as embezzlement, theft, acceptance of a kickback, and conflict of interest, the conduct also violates the employee/agent’s duty of loyalty and maybe redressed as such in addition to or instead of the underlying offense.

The duty of care means that people in a fiduciary relationship must act with such care as an ordinarily prudent person would employ in similar positions. Corporate officers, directors, or high-level employees, as well as other people in a fiduciary relationship, must conduct their business affairs prudently with the skill and attention normally exercised by people in similar positions. Fiduciaries who act carelessly or recklessly are responsible for any resulting loss to the corporate shareholders or other principals. Damages may be recovered in a civil action for negligence, mismanagement, or waste of corporate assets. People in a fiduciary relationship, however, are not guarantors against all business reverses or errors in judgment. In many countries, the business judgment rule protects corporate officers and directors from liability for judgments that were made in good faith (e.g., free of self-dealing or conflicts) and appeared to be prudent based on the then-known circumstances. Corporate defendants in such cases might raise the business judgment rule in defense by showing that they had no reasonable grounds to suspect such conduct or that the cost of prevention or recovery was too high compared to the anticipated returns.

Gross negligence is a civil cause of action, and it can be generally defined as the intentional failure to perform a duty in reckless disregard of the consequences to the victim. Although the exact definition varies by jurisdiction, the basic elements of this civil cause of action are that the defendant committed an intentional act, knowing that it was at least substantially likely to cause harm to the victim. In the employment context, employees have a duty to act in the best interests of their employers. So, if an employee consciously steals from his employer, the employee has breached his duty to act in the best interest of his employer and caused harm to his employer. Further, if the employee knew that the harm resulting from his wrongful act was
likely to occur when he committed the act, his actions may rise to the level of gross negligence. Generally, punitive or exemplary damages are available if the defendant is found liable for gross negligence.

Conspiracy refers to a situation in which two or more people agree to commit an illegal act. In most jurisdictions, the crime of conspiracy is actually a separate criminal offense from the underlying crime, meaning that the underlying crime (e.g., bank fraud, bribery, securities fraud, etc.) and the conspiracy to commit it are two separate offenses. The Law Related to Fraud Law 2.218 2017 Fraud Examiners Manual (International) The essential elements that must be shown to prove a conspiracy is as follows:
1. The defendant entered an agreement with at least one person to commit an illegal act.
2. The defendant knew the purpose of the agreement and intentionally joined in the agreement.
3. At least one of the conspirators knowingly committed at least one overt act in furtherance of the conspiracy.

Obstruction of justice occurs when an individual engages in an act designed to impede or obstruct the investigation or trial of other substantive offenses. Prosecutors usually are pleased to discover such violations by defendants because they add a more sinister flavor to what might be colorless white-collar charges and such actions can help to prove criminal intent. Jurisdictions might have several criminal obstruction statutes. Some common types of obstruction statutes are those that prohibit:
1. Influencing or injuring any officer of the court or juror by force, threats of force, intimidating communications, or corrupt influence
2. Influencing a juror through a writing
3. Stealing or altering records or processes by parties that are not privy to the records
4. Using force or threats of force to obstruct or interfere with a court order
5. Destroying documents related to a future proceeding
6. Tampering with a witness, victim, or an informant (e.g., killing or attempting to kill, using force or threats of force, intimidating, influencing with bribes or other corrupt means, misleading, or harassing the protected parties)
7. Influencing, obstructing, or impeding a government auditor in the performance of his official duties
8. Obstructing the examination of a financial institution

Obstruction of justice occurs when an individual engages in an act designed to impede or obstruct the investigation or trial of other substantive offenses. Prosecutors usually are pleased to discover such violations by defendants because they add a more sinister flavor to what might be colorless white-collar charges and such actions can help to prove criminal intent. Jurisdictions might have several criminal obstruction statutes. Some common types of obstruction statutes are those that prohibit:
1. Influencing or injuring any officer of the court or juror by force, threats of force, intimidating communications, or corrupt influence
2. Influencing a juror through a writing
3. Stealing or altering records or processes by parties that are not privy to the records
4. Using force or threats of force to obstruct or interfere with a court order
5. Destroying documents related to a future proceeding
6. Tampering with a witness, victim, or an informant (e.g., killing or attempting to kill, using force or threats of force, intimidating, influencing with bribes or other corrupt means, misleading, or harassing the protected parties)
7. Influencing, obstructing, or impeding a government auditor in the performance of his official duties
8. Obstructing the examination of a financial institution