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Tracy L. Coenen, CPA, MBA, CFE is a fraud expert and President of Sequence Inc., a forensic accounting firm with offices in Milwaukee and Chicago. She conducts financial investigations for private and public companies, reports her findings to executives and boards of directors, and testifies in court as an expert witness. She has provided fraud-related commentary to television and print media. Her commentary has been featured on NBC news and on CNBC's personal finance show, On the Money, and her comments have been printed in the Wall Street Journal, USA Today, BusinessWeek.com, CBSNews.com, and Entrepreneur.com, among others. Tracy writes articles on fraud for national business publications including Fraud Magazine.

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Praise for Expert Fraud Investigation

"Fraud is a constant evil that attacks businesses, consumers, and government. The financial and reputational impact of fraud can be devastating, but education and awareness are key weapons in the war on this crime. With this new book, Tracy Coenen delivers an excellent primer on the many fraud schemes as well as practical investigative techniques to detect and prevent fraud."
―Martin T. Biegelman, Director of Financial Integrity, Microsoft Corporation

"The lack of effective fraud training by auditors made my job easier as the criminal CFO of Crazy Eddie. I was lucky, since Tracy Coenen was too young to be a forensic accountant back in my criminal days. Acclaimed forensic accountant Tracy Coenen's fraud investigation book will cause many criminals to take early involuntary retirement or be forced out of business."
―Sam E. Antar, WhiteCollarFraud.com

"In Expert Fraud Investigation, Tracy Coenen does an excellent job of educating the reader on a wide variety of fraud schemes and providing a step-by-step process on how to conduct a fraud investigation. This is a must-read for anyone who wants to learn more about the basics of how to prevent, detect, and investigate fraud."
―Cynthia Cooper, Author of Extraordinary Circumstances: The Journey of a Corporate Whistleblower

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Expert Fraud Investigation

A Step-by-Step Guide

A sharp, savvy examination of financial fraud, Expert Fraud Investigation: A Step-by-Step Guide is one of the few books to take the leap from theoretical discussion to the actual nuts and bolts of performing an investigation. Fraud expert Tracy Coenen offers an insider look at many of the most common types of fraud cases and points out some of the best methods for analyzing the books and records to search for proof of fraud.

An invaluable tool to help professionals understand how financial fraud occurs in an organization and what to do when it is found or suspected, all the guidance needed to uncover corporate fraud is here, from the point of opening an investigation, selecting a team, through the entire investigative process, including:

• The most common fraud schemes

• The difference between audits and investigations

• Effectively managing the investigation

• Looking for fraud in little things

• Using public and private records in investigations

• Getting creative as a fraud investigator

• Uncovering asset misappropriation schemes, financial statement fraud, corruption schemes, and external fraud schemes

• How to prevent fraud from happening in the first place

Does your organization need to conduct a fraud investigation? Who needs to be involved? Expert Fraud Investigation gives you access to all the necessary background on fraud, the various types of fraud investigations, as well as the legalities involved. Making a difficult undertaking more manageable, this essential book arms you with the tools to take your organization step by step through the process of an effective fraud investigation.

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Expert Fraud Investigation

John Wiley & Sons

Chapter One

There are two different ways that a reactive fraud investigation starts. One type of investigation begins when an actual fraud has been identified, and maybe one or more perpetrators are identified, too. The other type of investigation starts with a strong suspicion of fraud, but no real proof of theft.

Both types of investigations are important to any organization that takes fraud prevention and control seriously. Companies with good fraud prevention controls actively monitor their systems and follow up on questionable data and unusual relationships between numbers. The investigation that starts this way should not be viewed as any less important than the one that begins with a definitive instance of fraud.

Signs of Fraud

Numerous signs can point to the possibility of fraud. Literally hundreds of different types of fraud schemes exist, so the number of possible red flags of fraud is huge. It would be impossible to cover them all in their entirety here, but some general signs of fraud can apply across all types of businesses and fraud schemes.

It is important to educate management and employees on these warning signs of fraud. Study after study indicates that tips from employees are one of the most common ways that corporate fraud is detected. Therefore, it makes sense to educate employees about symptoms of fraud so they can report red flags when they see them.

Accounting Irregularities

Irregularities that point to the possibility of fraud can range from simple things like unreconciled accounts and unusual account balances to more complex problems like "on-top entries," which are made after the books are closed in order to manipulate the numbers ultimately reported on the financial statements.

An auto dealership had a controller who had not reconciled the bank accounts for nearly a year, despite management's insistence that it be done. Management did not insist enough, and the problem persisted; the accounts remained unreconciled month after month. Unreconciled bank accounts usually signal one of two problems: The accounting staff is incompetent or understaffed, or there is a fraud-in-progress that will likely be exposed through a bank reconciliation. Both of these problems need to be corrected quickly.

In this case, it turned out that the controller simply couldn't handle all of the responsibilities of her job. She was out of her league and was not doing the reconciliations because she did not have time and was likely afraid that the reconciliations would expose her incompetence. The reconciliations would have shown that she didn't have a good handle on the company's finances.

The auto dealership was lucky in this case. They simply dismissed the controller and hired someone more experienced and more competent. But there was a period of time during which management was afraid a fraud had occurred. They should have recognized early on that the unreconciled accounts were a sign of a big problem.

Cynthia Cooper, head of internal audit at WorldCom, recounts the on-top entries problem that she and her team discovered was part of a massive fraud scheme at the company. Executives were directing employees to make journal entries on top of the regular general ledger activity to make the financial statements conform to a predetermined template. Lower-level employees did not see these entries, because they occurred outside the regular system of recording accounting details, so the practice went on for a long time before it was discovered.

To further confuse anyone who might look at the on-top entries, executives directed a web of confusing entries to be made. They were not a handful of simple debits and credits. There were hundreds of entries, with figures divided and bounced between many different accounts, apparently in an attempt to confuse and discourage anyone who might try to dig into these entries. The existence of these entries was discovered because of some irregular numbers and account names by the internal audit team. This demonstrates the importance of being on the lookout for unusual accounts, numbers, and descriptions within the accounting system.

It's not always easy to spot accounting irregularities. After all, an employee or executive who engages in fraud is often aware of what others are expecting their work or their numbers to look like. In many companies, management knows that revenue and expenses are expected to fall within certain parameters. Numbers outside of those expectations might raise suspicions. So a good fraudster will ensure that the numbers do not appear unusual in that regard. It's only when someone digs deeper that the irregularities start to surface. An examination of a public company's Securities and Exchange Commission (SEC) filings might reveal some notes or disclosures that do not make sense in light of the numbers reported. Small clues like these will be necessary to point to irregularities.

For example, suppose a company reports in the notes to the year-end financial statements that the raw materials used to make its products have become significantly more expensive. An examination of the company's gross profit margin, however, shows that the percentage is stable. The only legitimate way for the gross profit percentage to remain unchanged during a period in which raw material prices increase significantly is for the sales price of the goods to rise proportionately. The sales prices at this company did not change, however, so that immediately raises a red flag about that unchanged gross profit margin. The numbers reported don't make sense in light of the information provided in the notes. This should definitely be examined further.

It is clear that the accounting irregularities giving rise to a fraud investigation may not be easily identifiable. Those committing financial statement fraud are often adept at covering their tracks, so the red flags are not always obvious. The investigator often relies on intuition when examining the numbers and explanations for possible irregularities.

Apparent Control Weaknesses

When readily apparent major deficiencies in a company's control procedures are identified, they should be considered warning signs that fraud could be occurring. All companies have some things that are not as secure as they should be. However, when the controls over a company's assets and data are severely deficient, that is cause for alarm.

Some of the most common characteristics that might be considered severe deficiencies include:

* Complete lack of segregation of critical duties, giving one or more persons almost complete control over a financial area of a company and offering many opportunities to commit fraud and easily conceal it. For example, if the same person receives customer payments, records the payments to the customer's accounts, makes the bank deposits, and reconciles the bank statement, there are many opportunities to commit and conceal fraud. The employee could steal a customer payment, record the payment on the customer's account so the customer doesn't know the funds have been stolen, and later adjust the accounting records while doing the bank reconciliation in order to cover the theft. If these duties are segregated among two or three employees, the risk of theft of a customer payment and subsequent acts to...