|
What is Fraud?
Recognizing the Elements of Fraud
By
Mark R. Simmons, CIA CFE
A
government agency official directs the owner of a company doing
business under contract to provide equipment and contractor
staff that will be used to perform non-contract related work for
the agency. When seeking payment, the contractor bills the hours
for non-contract work as having been expended on contract
related activity. The billing occurs with the knowledge of the
agency official, and the agency official instructs lower level
staff to approve the bill for payment from agency accounts.
Because the contract is part of a federally funded program, the
agency in turn files a claim for reimbursement with the federal
government, which the federal government, in good faith, pays.
Some people might say that the agency official is a creative
manager. I'd say that agency official is a crook.
FRAUD occurs when all of the following elements exist:
-
an individual or an organization intentionally makes an
untrue representation about an important fact or event:
-
the untrue representation is believed by the victim (the
person or organization to whom the representation has been
made);
-
the victim relies upon and acts upon the untrue
representation;
-
the victim suffers loss of money and/or property as a result
of relying upon and acting upon the untrue representation.
Fraud can be for the benefit and gain of an individual, or for
the benefit and gain of an organizational entity or program.
When an individual commits fraud, the benefits and gains may be
direct (receipt of money or property), or indirect (reward of
promotions, bonuses, power and influence). When an organization
(actually an employee acting on behalf of the organization)
commits fraud, the benefits and gains to the organization are
usually direct, in the form of financial gain.
Some states have specific fraud statutes. Other states may have
specific laws to deal with bribery and corruption; and may
prosecute other types of fraud under larceny, robbery,
embezzlement or other specific statutes. Whenever the U.S.
government is injured through fraud, the matter falls within the
jurisdiction of the US Justice Department and the federal
courts. Therefore, a fraud could be prosecuted as a felony under
both state and federal laws. In addition, under U.S. federal
Law, anyone who engages in fraudulent activity and uses
telephones, telegraph and/or the Postal Service to discuss or
either send or receive correspondence or documents in
furtherance of the fraud, can be prosecuted for felony mail
fraud and/or wire fraud; and if two or more persons act in
collusion to defraud, U.S. federal conspiracy statutes also
apply. Also, under U.S. federal law, anyone who has knowledge
that a felony fraud has actually been committed against the U.S.
government; fails to report the fraud to appropriate
authorities; and helps to conceal the fraud by giving false
information, concealing facts, obstructing justice, or taking
some other positive action, is also guilty of a felony crime
punishable by up to three years in federal prison.
In
addition to the general laws governing fraud, there are U.S.
laws that deal with and/or regulate specific industries and
business transactions. These laws also usually contain specific
statutes for prosecuting fraud. Some examples would be statutes
pertaining to bank fraud, forgery or insurance fraud.
Generally, there are twelve crimes that fall under the umbrella
of Fraud.
1. Bribery
Bribery is the giving, receiving, offering, or soliciting of any
"thing of value" in order to influence an official in the
performance of, or failure to perform, the lawful duties of that
official. This includes influencing or soliciting the
commission, or collusion to commit, any other type of fraud; or
influencing an official, or soliciting by an official, to do, or
omit to do, any act that violates the lawful duty of that
official. Bribery defrauds the victim (usually an organization
or political entity) of the right to honest and loyal services
from those employed by the victim.
2. Commercial Bribery
Commercial bribery is the giving, receiving, offering or
soliciting of any "thing of value" in order to influence a
business decision without the victim's (usually a business
organization's) knowledge or consent.
3. Illegal Gratuity
An
illegal gratuity is the giving, receiving, offering or
soliciting, after the fact, of any "thing of value" for or
because of an official act that has been taken.
Following are examples of bribery and illegal gratuities:
-
A government inspector solicits payment from the owner of a
business regulated by a government agency. In return, the
inspector fails to report important safety and financial
violations discovered during the last inspection. In this
situation, the victims are those who rely upon the honest
reporting of deficiencies, and the loss is salary paid to
the inspector for work not performed, plus any damages that
result from failure to perform.
-
The owner of a company doing business under contract for an
organization knows that the manager responsible for
overseeing the contractor's activities plays an influential
role in deciding whether or not the contractor is
satisfactorily meeting the performance terms and conditions
of the contract. The manager uses personal influence and
position to assure that the contractor receives satisfactory
performance evaluations and is paid, even though the
contractor's work is substandard, and lower level staff in
the organization have legitimate concerns about the cost of
the contract and the contractor's ability to perform. The
contractor secretly gives financial and other incentives to
the manager in return. In this situation, the victims are
those who expect satisfactory performance of contract terms.
The loss is dollars paid for unsatisfactory work.
-
A senior organization official accepts financial and other
incentives from a contractor to assure that a request for
proposals is written in such a way that only that one
contractor will be able to submit a satisfactory bid
proposal. In addition, the senior official uses personal
influence and position to persuade other senior officials
that a good faith effort to obtain competitive bids has been
made. As a result, the favored contractor wins the bid award
at a noncompetitive price. In addition, once the contract is
in effect, the same senior official approves and justifies
several high cost contract amendments, for which additional
illegal gratuities are received. In this situation, the
victims are those who expect a fair and impartial
competitive procurement process. The loss is dollars
needlessly spent as a result of noncompetitive pricing and
price gouging.
4. Conflict of Interest
A
conflict of interest occurs when a person or organization acts
on behalf of another individual or organization; and has, or
appears to have, a hidden bias or self-interest in the activity
undertaken; and the hidden bias or self-interest is actually or
potentially adverse to the interests of the individual or
organization being represented; and the hidden bias or
self-interest is not made known to the individual or
organization being represented. When a person's conflict of
interest results in economic or financial loss to the individual
or organization on whose behalf the person is acting, then fraud
has occurred. Conflict of interest can exist on its own, or can
be an intricate part of other frauds such as bribery and illegal
gratuities. Conflict of interest laws apply to government
employees and those doing business with government. In the
non-public sector, conflict of interest may not be a
prosecutable offense, although the criminal results of such
conflict would be.
-
The examples given for bribery and illegal gratuities are
also examples of conflict of interest resulting in fraud.
-
Conflict of interest can also occur and result in fraud
without the presence of bribery and illegal gratuities. This
happens when an individual or organization acting on behalf
of another individual or organization has a hidden financial
interest in the outcome of an event or transaction. The
typical example is that of a company official or employee,
or an immediate relative of an official or employee, who has
a hidden financial interest (stock or direct ownership) in a
vendor doing business with the company. If the official or
employee is in a position to influence the amount of
business the vendor does with the company, then a conflict
of interest exists. If that conflict of interest results in
unnecessary orders being filled, or paying higher than fair
market prices for the goods or services, then fraud has
occurred. This is because the involved individuals will
benefit financially through higher valuation of stock or
direct distribution of proceeds from doing business with the
company. The victims here are those who expect company
officials and employees to act in the best interests of the
company, rather than in self-interest. The loss is dollars
needlessly spent on overpriced or unnecessary goods and
services.
-
Conflict of interest can also exist and result in fraud when
an organization has a hidden interest or benefit from the
outcome of an event or transaction. In a government
environment, for example, this more subtle type of conflict
of interest could occur if government officials, acting on
behalf of the government, either alone or in conspiracy with
providers of services, obtain state and federal funds and
use those funds for other than intended program purposes. In
this instance, the government agency, in acting as the
conduit of state and federal funds, has a hidden
self-interest that is actually or potentially adverse to the
interests of the state and federal government. An example of
this would be the following situation: An agency official
directs the owner of a company doing business under contract
with the agency to provide the agency with equipment and
contractor staff that will be used to perform work for the
agency that is unrelated to the terms and conditions of the
contract, and unrelated to the federal program under which
the contract is funded. This favor and benefit creates a
conflict of interest because there is no longer an arms
length relationship between the agency, which acts on behalf
of the government, and the contractor. When seeking payment,
if the contractor intentionally bills the hours for
non-contract work as having been expended on contract
related activity, then the contractor has committed fraud.
If the fraudulent billing occurs with the knowledge of the
agency official; and/or the agency official instructs lower
level staff to approve the bill for payment from agency
accounts; and the agency in turn files a claim for
reimbursement with the federal government, which the federal
government, in good faith, pays, then the agency official
has also committed fraud under federal law. The example
given is a fraudulent act resulting from conflict of
interest because the actions of self-interest by the
contractor and the official acting on behalf of the agency
are hidden from the state and federal governments, and
constitutes obtaining state and federal funds under false
pretense (see False Statements and False Claims, below). The
victims are the state and the federal government, from which
the funds were obtained, and the loss is the funds illegally
obtained.
5. False Statements and False Claims
A
false statement fraud and false claims fraud occur whenever
anyone knowingly and willfully falsifies a material fact or
makes a false or fictitious representation or files a false or
fictitious claim that results in economic or financial loss to
the party to whom the false representation has been made.
Example of False Statements and False Claims:
-
An employee prepares and submits a monthly payroll time
report, and intentionally falsifies the document by not
reporting unpaid leave taken while the supervisor was away
on business. As a result, the employee is paid for the time
not worked. The same principle applies to an employee who
falsifies a travel voucher by reporting expenses that were
not incurred. The victim is the employer, and the loss is
the money wrongfully paid to the employee.
-
A senior company official disagrees with a court decision
for which all legal remedies have been exhausted, and which
the company must therefore comply with. The decision has a
significant financial impact on operations. The senior
official knowingly and intentionally continues practices
that the court decision has prohibited. The failure to
comply with the ruling results in the chief operating
officer filing false statements, reports and vouchers with
the government. The victims are those who rely on accurate
reporting to the government, and the loss is funds illegally
obtained or expended; or economic or property losses
incurred because of the improper reporting.
-
A company performs contract work for a government agency.
Under the direction of company managers, staff charge time
to a government program that reimburses 75% of incurred
costs, instead of charging the time to the actual government
program that they worked on, which only reimburses 50% of
incurred costs. The employees recognize that the wrong
program is being charged for their time, but are unaware of
the differing reimbursement percentages. When the employees
question their instructions, the company managers tell them
not to worry since both programs are paid from government
funds, and the cross-charging doesn't really matter. The
government is subsequently fraudulently mischarged as a
result. The company managers have engaged in fraudulent
activity that results in false statements, false claims, and
probably mail fraud. Under U.S. law, the employees who filed
the false time reports are guilty of conspiracy to defraud.
Though the employees neither benefited from the mischarging,
nor were aware that the mischarging was illegal, they are
also parties to false statements, false claims, mail fraud
and conspiracy statutes. The employees knew they were
improperly charging their time, and by falsely preparing the
time documents, the employees concealed the fraud. Whether
they knew that the mischarging was illegal is not a
consideration. As a result of the employees' actions, when
the government was billed for reimbursement, the company
managers were able to defraud the government of costs that
should have been borne by the company.
6. Extortion
Extortion occurs when a person or organization obtains something
from another individual or organization under color of official
office and/or through the use of actual or threatened force or
fear, including fear of economic or fiscal loss.
Examples of Extortion:
-
A government inspector solicits payment from the owner of a
business regulated by a government agency, and in order to
secure the payment, the inspector threatens the business
owner with charges of severe code violations and heavy
fines. Faced with a threat of economic and fiscal loss, the
business owner makes the payment. In this situation, the
victims are those who rely upon the honest reporting of
safety issues and deficiencies. The loss is salary paid to
the inspector for work not performed and the money extorted
from the business.
-
An official responsible for contract procurements also has
a great deal of influence among contract procurement
officers in other companies and government agencies. The
official informs a contractor that in order to continue
receiving contracts, the contractor must provide special
gratuities, favors or services without compensation to the
contractor. If the contractor fails to cooperate, the
official threatens to blacklist the contractor and cut the
contractor off from any further work. Faced with a threat of
economic and fiscal loss, the contractor complies. In this
case, the victims are those who rely upon the official to
carry out duties and responsibilities with honesty and
integrity. The loss is the cost to the contractor of
providing non-reimbursed services.
7. and 8. Mail Fraud and Wire Fraud
Under U.S. federal law, anyone who engages in fraudulent
activity and uses telephones, telegraph and/or the U.S. Postal
Service to discuss or either send or receive correspondence or
documents in furtherance of the fraud, can be prosecuted for
felony mail fraud and/or wire fraud.
Examples of Mail and Wire fraud:
-
If any of the perpetrators of the previously described
crimes used the postal system to mail reimbursement claims,
mail bid announcements, exchange correspondence with
co-conspirators or victims, submit/return contract
amendments, or in any way used the postal system to carry
out the fraud, then they can be prosecuted for mail fraud.
Similarly, if a modem was used to electronically exchange
data or file claims related to the fraud; or if
co-conspirators discussed related activities over the
telephones, or in any way used telephones or telegraph to
carry out the fraud, then they can be prosecuted for wire
fraud.
9. Conspiracy
Conspiracy occurs when there is the specific intent that a crime
be performed; and there is an agreement with another person to
engage in or cause that crime to be performed, and one of the
conspirators commits an overt act in furtherance of the
conspiracy. At state and local levels, there are various degrees
of conspiracy, ranging from misdemeanors to felonies, depending
upon the crime that is committed. Under U.S. federal law,
conspiracy is a felony. When two or more persons conspire to
defraud the United States, or any agency of the United States,
for any purpose or in any manner, each person is subject to a
$10,000 fine and imprisonment of five years.
Examples of Conspiracy
10. Breach of Fiduciary Duty
A
breach of fiduciary duty occurs when a person, who is employed
by and owes a duty to an organization or another individual,
does something that is not in the best financial interest of
that organization or individual. Breach of fiduciary duty is a
civil matter, not a criminal offense. However, as a civil
offense, the elements of proof required for conviction are
considerably simpler than for criminal fraud, and it is not
necessary to prove wrongful intent.
Examples of Breach of Fiduciary Duty:
-
All the previously cited examples of bribery, illegal
gratuities, fraudulent conflict of interest, and making
false statements are felony crimes. They are also breaches
of fiduciary duty. This means that in addition to criminal
charges, the persons who have committed wrongful acts can be
sued for damages in civil court.
-
There are other types of breach of fiduciary duty. These
fall under the umbrella of gross negligence, gross
mismanagement, and abuse. An example would be failure to
design adequate systems of internal controls that ensure the
accuracy of data and information upon which company funds
are disbursed. The victim is the organization, and the loss
is the funds inappropriately disbursed.
11. Embezzlement
Embezzlement is the fraudulent conversion of personal property
by a person in possession of that property where the possession
was obtained pursuant to a trust relationship.
Examples of Embezzlement:
Kiting can occur when a bank allows withdrawals to be made
on checks deposited by a customer but for which the actual
funds have not yet been collected from the bank on which the
check is drawn. In reality, the cash could either be in
transit or non-existent. Goods and services are then
purchased, or cash is obtained from legitimate sources, by
writing checks against non-existent account balances. The
fraud is perpetuated by continuous "kiting" from bank to
bank checks that are drawn on non-existent funds . In a
kiting scheme, the victim is usually the bank that has paid
out on uncollected deposits, and the loss is the money paid
out by the bank.
Lapping is the use of funds received from payment of
accounts receivable to cover a theft of cash. The
perpetrator initially steals cash tendered in payment of an
outstanding receivable. To cover the initial theft, a
payment made by a second customer is charged against the
account from which the initial theft was made, thus
"lapping" the two accounts. Payment from a third customer is
used to cover the second account, and so on. The victim in a
lapping scheme is usually the company from whom the money
was stolen, and the loss is the amount of money stolen.
12. Failure to Report a Federal Felony to Appropriate U.S. Law
Enforcement Authorities
If
an individual: knows that a fraudulent act has been committed
under federal law; and fails to report the fraudulent act to
appropriate U.S. law enforcement authorities; and then actively
engages in concealing the fraudulent act or evidence of the
fraudulent act; then that individual is guilty of a felony crime
punishable by up to three years in U.S. federal prison. Examples
of acts to conceal fraud include: changing, hiding or destroying
official records in order to conceal the fraudulent act;
suppression of evidence regarding the fraudulent act; directly
or indirectly causing others to withhold or suppress information
pertaining to the fraudulent act; making false statements to
investigators regarding the fraudulent act; or any other
affirmative action designed to conceal the fraudulent act from
authorities. Consider the implications of this for auditors:
Since the auditor's primary duty is to examine, evaluate and
report, if an auditor becomes aware of fraudulent activity, and
fails to report it to appropriate law enforcement authorities, a
prosecutor could argue that the failure to report is an
"affirmative act" by the auditor to conceal the fraud. (For a
discussion of the legal implications facing an internal auditor
who has discovered wrongdoing, I suggest the article "Dealing
With Known Corporate Wrongdoing", by Michael Meier, J.D., and
Larry Rittenburg, PhD, CIA, CPA, that appeared in the April 1986
issue of Internal Auditor magazine.)
How
can the potential for fraud be dealt with? One crucial weapon in
the internal auditor's arsenal is a comprehensive fraud policy,
such as the example presented in the article "Fighting Fraud",
which appeared in the August 1992 issue of Internal Auditor
Magazine.
We
have an obligation to exercise reasonable and due care in our
work, and must be alert to the possibility of wrong doing and
conflict of interest in our organizations. In this article,
we've looked at the overall issues associated with fraud, and
some of the many fraud risks involved. However, this article on
recognizing the elements of fraud is meant only to inform. It is
not a substitute for professional legal advice. As always in
matters of law, he who counsel's himself has a fool for a
client. If you need legal advice or an interpretation of law,
seek out a qualified attorney.
Copyright © 1995 Mark R. Simmons
www.facilitatedcontrols.com
Some of the concepts used in this article have been adapted from
material contained in the Certified Fraud Examiner's Manual
(published by the Association of Certified Fraud Examiners) and
in a presentation on fraud by W. Michael Kramer, J.D., CFE. The
example of false statements and claims that resulted from
cross-charging government programs was adapted from the article
"Avoiding Corporate Self-Incrimination", the Internal Auditor
Magazine, April 1986
Send
questions or comments about this website to
webmaster@cocfe.org
Copyright © 2011 Colorado Chapter of the Association of
Certified Fraud Examiners
Last modified:
02/07/2011
|
Home
