CFE Exam Quiz 17

There are many reasons why organizations choose to conduct fraud examinations. These include:
1. Identifying improper conduct
2. Identifying the persons responsible for improper conduct
3. Stopping fraud
4. Sending a message throughout the organization that fraud will not be tolerated
5. Determining the extent of potential liabilities or losses that might exist
6. Helping facilitate the recovery of losses
7. Stopping future losses
8. Mitigating other potential consequences
9. Strengthening internal control weaknesses

A corporation’s directors and officers owe a common law duty of care to their organization and shareholders, and therefore, when suspicions of fraud arise, it might be necessary for them to conduct an investigation to ensure that they have full knowledge of such issues affecting the company.

Fraud can be discovered in several ways, such as via a tip or complaint, an auditing procedure, monitoring, or chance.

Because tips are the most valuable resource for discovering internal fraud, companies should proactively seek them out by implementing easily accessible and anonymous (where permitted by law) fraud reporting tools.

Fraud examination refers to a process of resolving allegations of fraud from inception to disposition, and it is the primary function of the anti-fraud professional.

The fraud examination process encompasses a variety of tasks that might include:
1. Obtaining evidence
2. Reporting
3. Testifying to findings
4. Assisting in fraud detection and prevention

A fraud examination report is a narration of the fraud examiner’s specific activities, findings, and, if appropriate, recommendations.

Many fraud examinations can be considered forensic accounting, but not all forensic accounting is fraud examination.

Forensic accounting can include many professional services. Typically, forensic accountants perform assignments involving:
1. Computer forensics
2. Electronic discovery
3. Bankruptcies, insolvencies, and reorganizations
4. Workplace fraud investigations
5. Calculations of economic losses
6. Business valuations
7. Professional negligence

The fraud examination methodology establishes a uniform, legal process for resolving signs or allegations of fraud on a timely basis. It provides that fraud examinations should move in a linear order, from the general to the specific, gradually focusing on the perpetrator through an analysis of evidence.

When conducting a fraud examination, the fraud examiner should assume litigation will follow, act on predication, approach cases from two perspectives, move from the general to the specific, and use the fraud theory approach.

Predication is the totality of circumstances that would lead a reasonable, professionally trained, and prudent individual to believe that a fraud has occurred, is occurring, or will occur.

Predication is the totality of circumstances that would lead a reasonable, professionally trained, and prudent individual to believe that a fraud has occurred, is occurring, or will occur. In other words, predication is the basis upon which an examination, and each step taken during the examination, is commenced.

Each fraud examination should be conducted with the assumption that the case will end in litigation. This will ensure that the fraud examiner maintains accordance with the proper rules of evidence and remains well within the guidelines established by the legal systems.

The requirement for predication, however, does not bar fraud examiners from accepting other forms of engagements in circumstances where predication is lacking. For example, if employees appear to be living beyond their means (i.e., living a more extravagant lifestyle than their income would seem to allow), there could be many reasons other than fraud to explain the disparity, such as an inheritance, a higher-earning spouse, or royalties received from mineral rights; however, in such circumstances, a fraud examiner can conduct a fraud risk assessment for consulting purposes even if there is not necessarily reason to believe a fraud has occurred, is occurring, or will occur.

Fraud examiners should approach investigations from these perspectives: (1) by seeking to prove that fraud has occurred and (2) by seeking to prove that fraud has not occurred.

Fraud examinations commence when the full facts are unknown or unclear; therefore, they should proceed from the general to the specific.

Fraud examiners should approach investigations from two perspectives: (1) by seeking to prove that fraud has occurred and (2) by seeking to prove that fraud has not occurred.

To prove that a fraud has occurred, the fraud examiner must seek to prove that fraud has not occurred. The reverse is also true. To prove fraud has not occurred, the fraud examiner must seek to prove that fraud has occurred. The reasoning behind this two-perspective approach is that both sides of fraud must be examined because under the law, proof of fraud must preclude any explanation other than guilt.

The usual order of interviews during a fraud examination is as follows:
1. Neutral third-party witnesses, starting with the least knowledgeable and moving to those who are more knowledgeable about the matters at issue
2. Parties suspected of complicity, starting with the least culpable and moving to the most culpable
3. The primary suspect(s) of the examination

The fraud theory approach has four steps.

The fraud theory approach involves the following steps:
1. Analyzing available data
2. Creating a hypothesis
3. Testing the hypothesis
4. Refining and amending the hypothesis

A fraud response plan outlines the actions that members of an organization will take when suspicions of fraud have arisen. Because every fraud is different, the response plan should not outline how a fraud examination should be conducted. Instead, it should help organizations manage their responses and create environments to minimize risk and maximize the potential for success.

The elements of a fraud response plan include:
1. Reporting protocols
2. A response team responsible for conducting an initial assessment
3. Factors used to determine the course of action
4. Litigation hold procedures

The response team members will vary depending on the facts and the potential severity of the suspected fraud, but the team might include:
1. Legal counsel
2. A representative of management
3. A Certified Fraud Examiner
4. The finance director
5. General counsel
6. A representative of internal audit
7. Audit committee members
8. A C-level executive

Each organization will have different criteria for deciding whether allegations or suspicions qualify for a formal investigation, but common ones include:
1. The credibility of the allegation
2. Type of incident
3. The subject of the allegation
4. The business purpose of the activity at issue
5. Seriousness or severity of the allegation
6. Potential negative impact
7. Likelihood that the incident will end up in court
8. The ways in which prior, similar incidents were handled

A litigation hold refers to the steps an organization takes to notify employees to suspend the destruction of potentially relevant records when the need to preserve information arises.

The failure to preserve relevant evidence could have several adverse consequences, including, but not limited to, the government’s questioning of the integrity of any fraud investigation, monetary fines and sanctions, adverse inference jury instruction sanctions, or dismissal of claims or defenses.

Litigation hold procedures should apply to individual communications (e.g., email, chat messages, voice recordings), data on shared devices (e.g., network folders), system backup files, and archived data.

When evidence of fraud arises, management should respond by engaging in the following actions:
1. Activate the response team.
2. Engage legal counsel, if necessary.
3. Consider contacting the insurance providers.
4. Address immediate concerns.
5. Conduct an initial assessment.
6. Document the initial response.