Uncovering Fraud: Case Studies in Financial Investigation

Fraud is a global issue, impacting stakeholders beyond financial losses and reputational damage — which is where a fraud audit comes into play. It is important now, more than ever, to understand the dangers and ramifications of fraud. Fraud is capable of wreaking havoc on businesses, investors, employees, and entire industries. We’ll seek to understand some of the most notorious and insidious fraud schemes, delve into how these were identified and provide strategies and best practices to prevent fraud affecting your organisation.

What is Fraud?

Conceptually, fraud is any activity that relies on deception in order to achieve a gain. Black’s Law Dictionary states that fraud becomes a crime when it is a “knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment”. Interestingly, akin to the layers of an onion, fraud extends through layers including:

  • Initiation, where motives and opportunities give rise to the dishonest event or conduct. The recipe for fraud to be committed is referred to as the ‘fraud triangle’. You can read more about the ‘fraud triangle’ here.
  • Escalation, where the perpetrator actively conceals their actions to avoid detection. The concealment tactics can include manipulating records, social media or fictitious accounts, and even crafting opaque legal documents, and finally
  • Discovery, where the red flags point to issues requiring investigation and ultimately unmasking the fraud. You can read about potiential red flags here.

The importance of detecting and addressing fraud, with tactics such as an internal or fraud audit, in a timely manner to minimise its impact on stakeholders cannot be overemphasised. You can read about the statistics and financial losses relating to fraud, along with fraud red flags, here.

Some Of The Most Infamous Fraud Cases

The history of financial crime is marked by some infamous fraud cases that have shocked the world. These instances highlight the critical role of fraud audits in detecting and preventing deceptive practices.

This section will introduce some of the most notorious fraud schemes, serving as a prelude to deeper discussions on the subject. As we explore these cases, we will uncover the impact they had on their victims and industries.

The Enron Scandal

One of the most infamous cases of corporate fraud in history is Enron. Initially involved in natural gas transmission, Enron later transitioned into trading energy derivative contracts, fostering a culture of intense competition and deceptive accounting practices.

The energy company concealed massive debts from its balance sheet, resulting in catastrophic financial losses. Shareholders lost $74 billion, while thousands of employees and investors lost their retirement accounts. Many employees were left jobless.

The scandal was exposed when a whistleblower, suspicious of the company’s unusually high stock prices, revealed the fraudulent activities.

Lehman Brothers

The exploitation of loopholes in the semantics and application of accounting standards, along with an imagination stretching beyond the realms of the Disney Corporation or Pixar, allowed the financial services firm to sell toxic assets disguised as sales when in fact these were loans.

Unsurprisingly, the loans ultimately required repayment. The scandal was exposed in September 2008 when Lehman Brothers filed for bankruptcy – over US$600 billion.

Bernie Madoff’s Ponzi Scheme

The same year as the Lehman Brothers scandal came to light was this fraud, orchestrated by the American financier, who promised unusually consistent annual returns of around 10%.

In fact, Madoff and his accountants paid investors returns out of their money, or that of incoming investors, rather than profits. Through this scheme, Madoff defrauded investors more than an estimated US$60 billion.

Madoff and his accountants received hefty prison sentences. The scheme came to light following several warnings and reports from a whistleblower.

WorldCom

The WorldCom fiasco, perpetrated by a telecommunications company, is another prime example of corporate fraud. Worldcom inflated its assets by approximately $11 billion and recorded false accounting entries to increase revenues presented to the market.

 

The impacts were devastating, resulting in thousands of employees losing their jobs, investors suffering substantial financial losses and ultimately one of the largest bankruptcy filings in history.

 

The CEO was sentenced to 25 years in prison. A corporate whistleblower was the one to thank for bringing this to the attention of the auditors and board of directors.

Case studies in other companies and sectors

The following cases and examples emphasise the importance of transparency and accountability in the corporate world. For all organisations, large and small, the examples serve to demonstrate the significance of fraud awareness, as well as the need for robust internal controls, ethical culture, documented policies and procedures — and regular fraud audits to ensure the accuracy of financial reporting.

Misappropriation By Finance Manager

The finance manager of a large organisation was alleged to have misappropriated over $1 million from the organisation through cheque and expense payment fraud.

An investigation ascertained the amounts had been disguised through misstatement of accounts, liabilities not being recorded and falsifying supplier records. Inadequate segregation of duties and the compromising of bank signatories facilitated the fraud to occur.

Sales Commission Fraud

A retail organisation was concerned about the high outstanding debtor balances in the accounts receivable at year end. This was during a period with some of the worst weather on record. For this organisation, sales ordinarily were a product of good weather.

Enquiries made to some of the debtors identified a number of suspicious sales transactions which were denied by the debtors. Further investigation revealed a number of significant “credit notes” for the alleged sales.

It became apparent one sales manager had created fraudulent sales in order to generate fraudulent commission payments to themselves.

Inventory And Revenue Fraud

An electronics manufacturer saw the surprise resignation of its finance officer during a review into “credit returns”.

Further investigation established a significant proportion of sales invoiced to suspect suppliers had been falsely created, allowing the misappropriation of inventory from the warehouse by an accomplice working in the warehouse. The inventory had been sold privately with the proceeds being shared between the pair.

Corporate Espionage

An information technology company grew increasingly concerned following an increase in customer turnover. A formal customer exit interview was conducted, which led to a further internal review of current and terminated employees.
It was identified that a manager, who had recently resigned, had obtained access to a confidential database of clients, hardware and software support, and price lists.
The (former) manager saw the opportunity to target the organisation’s customers and offer cheaper prices. Accordingly, they established a separate business and set up in direct competition with their company.

Tips to Prevent and Combat Fraud

Fraud prevention and fraud detection are two separate, but interdependent, processes. Fraud prevention encompasses the systems, procedures, and policies organisations employ to prevent fraud.

Fraud detection on the other hand is monitoring transactions and performance to identify and respond to fraudulent activity after it has occurred. Prevention is better than cure, and you presumably don’t want your business to be the next victim of fraud, front page news article or online case study (*blushes*).

Fraud prevention strategies include:

  • Establish and promulgate the tone at the top: Tone at the top refers to the ethical atmosphere that is created by the organisation’s leadership. The Board and management has to lead by example and actions. These actions should include rewarding ethical behaviour while punishing unethical actions. There should be sanctions for engaging in, tolerating, or condoning improper conduct.
  • Establish a code of ethics: Organisations should produce a clear statement of management philosophy. It should include concise compliance standards that are consistent with management’s ethics policy relevant to business operations.
  • Establishing robust internal controls: This includes strong preventive controls such as segregation of duties, passwords and authentication, restricted access and custody, and ensuring no-one person controls end-to-end processes. This includes assigning appropriate authority and responsibility to functions and processes.
  • Education and training: Regular tailored training and education programs can help staff learn to recognise red flags and understand fraud prevention and detection best practices. Employees should know what to do if they detect suspicious activity or potential fraud and how to report it.
  • Establish a whistleblower policy: Companies should establish and communicate a whistleblower protection policy to allow employees to come forward and report misconduct in the workplace. This policy should allow employees to report or seek guidance regarding actual or potential criminal conduct by others within the organisation while retaining anonymity or confidentiality, without fear of retaliation.
  • Implement a confidential hotline: More frauds are detected by tip-off than any other means. Hotlines have proved to be a very effective reporting mechanism for stakeholders to call and confidentially report suspicious fraudulent activity. This also bolsters the ethical environment promoted by the organisation’s leadership.
  • Conduct regular audits and internal reviews: Regular audits and reviews prevent fraud and helps organisations maintain better control over their operations.

Tips to Prevent and Combat Fraud

A strong ethical culture, regular training and awareness, carefully designed and effectively operating internal control environment and ongoing internal and external audit activity offers the greatest preventative protection for your business against fraud. We should all be striving to “do the right thing” as this starts at the top.
For an obligation-free chat, get in touch with the Bishop Collins Audit team. We can assist you with audit and assurance services, during which our experts will provide advice and guidance on how to protect your business against fraud, or how to deal with any fraudulent activity you suspect.

If you’re interested in learning more about internal and external audit, fraud risk management, and awareness training, get in touch with us for an obligation-free chat or simply call us on (02) 4314 8020