Chapter 4
PREVENTING FRAUD
Discussion Questions
1. Three factors are crucial in creating a culture of honesty, openness, and assistance: hiring honest people and training them in fraud awareness; creating a positive work environment; and providing employee assistance programs (EAPs).
2. Five methods that companies can use to reduce actual or perceived opportunities for fraud are as follows:
a. Install good internal controls.
b. Discourage collusion, and alert vendors and contractors to company policies.
c. Monitor employees, and install tip hotlines.
d. Create an expectation of punishment.
e. Proactively audit for fraud.
3. Clearly defined codes of ethics delineate between what is acceptable and what is unacceptable. Having employees periodically read and sign the company’s code of ethics not only reinforces their understanding of what constitutes appropriate and inappropriate behavior; it also underscores the fact that their behavior is important to the company. Expectations are clarified, and clear expectations reduce fraud. Clearly specified codes also inhibit rationalizations, and, as previously discussed, rationalization is an important element of nearly every fraud.
4. The most widely recognized way to deter fraud is with a good system of internal controls. Internal controls include a good control environment, a good accounting system, and good control procedures as well as good communication and monitoring.
5. Much collusion can be prevented by simply enforcing mandatory vacations or job transfers, because collusive fraud develops slowly (it takes time to get to know others well enough to trust that they will cooperate and not blow the whistle). When organizations leave one employee in close contact with the same vendors or customers for long periods of time, the risk of individuals deciding to profit personally increases dramatically.
6. Sometimes otherwise innocent vendors and customers are drawn into fraud by perpetrators because they fear that if they do not participate they will lose the business relationship. In most cases, such customers or vendors have only one or two contacts with the firm, and the person who requested illegal gratuities or suggested other types of illegal behavior often intimidates them. A periodic letter to vendors that explains the organization’s policy of no gifts or gratuities helps vendors understand whether company buyers and sellers are acting in accordance with the rules. Such letters clarify expectations, something that is very important in preventing fraud. Many frauds are uncovered when, after receiving such a letter, vendors express concern about their buying or selling relationships.
7. People who commit fraud and hoard their proceeds are virtually nonexistent. Perpetrators almost always use their stolen money to support expensive habits. Organizations can monitor their employees by paying close attention to the enhanced lifestyles that result from these expenditures and by listening for verbalized rationalizations.
8. Proactive fraud auditing is conducted by following four steps: identifying risk exposures, identifying the fraud symptoms for each exposure, building audit programs that proactively look for symptoms and exposures, and investigating identified symptoms.
9. Even with advances in technology, fraud is most commonly detected through tips. A good whistle-blowing program is an extremely effective prevention tool. When employees know that colleagues have an easy, anonymous way to report suspected fraud, they are more reluctant to commit fraud.
10. When placed in an environment of low integrity, poor controls, loose accountability, or high pressure, people tend to become increasingly dishonest. While a few people probably will not become dishonest at any point (about 30%), a large portion of the population will be influenced by negative stimuli and eventually cave to dishonesty. In essence, this phrase means that a lot of people have a point where if the payoff is high enough, they will be dishonest.
11. Along with the standard interviewing, background and reference checks, some institutions are now conducting credit checks, checking employee’s fingerprints against law enforcement records, drug testing, and pen-and-pencil honesty tests.
12. The Pygmalion effect states that when expectations are set below average, results will be substandard. This relates to fraud in that if we expect people to be dishonest, they will often be dishonest. However, if we create a culture of honesty and expect employees to be honest, then employees will often be honest.
Multiple Choice
1. e
2. e
3. e
4. b
5. d
6. c
7. a
8. c
9. b
10. c
11. d
12. b
13. b
Short Cases
Case 10
The chapter states that a major factor in preventing fraud is to create a culture of honesty, openness, and assistance. In this case, there was no openness or assistance. No one communicated with this employee. Rather than assisting him, they treated him poorly and talked down to him. Fraud is usually high in this type of environment because employees see the company and its owners as adversaries rather than supporters.
Case 11
Jorge is a high risk for fraud because he is facing significant financial pressures to repay his student loans and because of his credit card debt. He is depressed, and has an alcohol problem, all of which will add to the desperation that often leads to employee fraud. An EAP could help Jorge deal with his financial, substance abuse and psychological problems and help him lead a financially healthy life. An EAP could help Jorge get medical assistance for his depression, and he could also get drug counseling for his alcohol problem. This assistance would reduce the likelihood that Jorge would succumb to the temptation to commit fraud.
Case 12
First, the program does not allow employees to feel like they are giving anonymous tips. If they are just calling someone in the office who is the fraud liaison, then that person may know the potential whistle-blower, which would obviously discourage employees from making calls. Many of them would fear retaliation from blowing the whistle. Second, if the liaison is involved in the fraud, there would be no one to call. Third, putting a notice in the break room is not sufficient. People must know about the program and be trained about how it works. This lack of training would also create failure in the program. Finally, top management must let employees know that the program is important to them and the company by frequently referring to the program.
Case 13
There are a number of techniques potential employers can use to screen to make sure they are hiring honest employees. Some mentioned in the book are background checks, reference checks, drug tests, criminal records checks, matching potential employees’ fingerprints against fingerprint databases and credit checks. An extensive interview would also be helpful in trying to assess the integrity of the potential employee.
Case 14
1. Hire honest people and provide fraud awareness training: Even in a small business, you can establish hiring procedures that will result in a more honest workforce. You may not be able to perform extensive background checks, but you can at least check references and perform other simple and relatively inexpensive screening processes. Even if you don’t have the resources to conduct lengthy fraud-awareness training seminars, discussions at the time of hiring or through the distribution of materials can provide new employees with information about how to handle fraud and the expected results of committing fraudulent behavior.
2. Create a positive work environment: Employees should be aware that either you or another appointed employee is always willing to listen to them with respect to reports of fraudulent activities. No one should be afraid to come forward. You might even create a means of anonymous reporting. This does not necessarily need to include expensive hotlines. It can be something as simple as a locked comment box. As well, it is very important that you do not override controls. It may be true that you will never rob your own company, but if your example is one of ignoring controls, you open the door for your employees to do the same.
3. Have a well-understood and respected code of conduct or ethics: You should find a way to inform all employees about what is expected of them with respect to fraudulent activities. This will remove part of their ability to rationalize their actions.
4. Provide an employee assistance program: Fraud usually results (at least in part) from pressures with which the employees are faced. You should attempt to monitor and mitigate these pressures by providing an alternative means for employees to receive assistance.
5. Create an expectation that dishonesty will be punished: You should always prosecute employees who steal from the company. The publicity this causes shouldn’t harm the company as much as the potential long-term effects that may ensue from not punishing dishonesty; most people realize that fraud affects all companies. In fact, your responsible actions against fraud might instill confidence in others that your company is addressing the problem in a healthy manner. Other employees will be less likely to commit fraud if they know they will be punished severely if caught. In the end, the savings will most certainly outweigh the costs.
