PLEASE ANSWER ME THE QUES 7 AND 8 , THANKS VERY MUCH. NEEDING DETAILED INFORMATION.

\freport high account receivable or low current liabilities segregation of duties,double checks, recheck the documents and records topic 3 3 aspects of fraud preventation a.Benford's law states the general proportions for frequencies of numbers(leading digits) in a data set. if the figures shows lower or higher than curve of benford's . it indicate the strangle data and needs fraud detection. If the data doesn't look anything like the distribution predicted by Benford's Law it may mean the numbers have been manipulated. a.see 4 and 5, in this case, staffs who in the purchasing department have manipulated lots of purchasing cost start with leading digit 4, related to facts. The over $500 purchasing must been approval, this fraud figure could been 499. That leads the 4 leading digit higher than natural number distrubution. b.thefts72, prove: someone act dishonest acts for permanently deprive appropriates properties which belongs to others \f1019763_FM_VOL-I.qxp 9/17/07 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 S 50 R 51 4:22 PM Page viii This page was intentionally left blank 1st Pass Pages 1019763_FM_VOL-I.qxp 9/17/07 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 S 50 R 51 4:22 PM Page viii This page was intentionally left blank 1st Pass Pages Fraud Examination FOURTH EDITION W. STEVE ALBRECHT Brigham Young University CHAD O. ALBRECHT Utah State University CONAN C. ALBRECHT Brigham Young University MARK F. ZIMBELMAN Brigham Young University Australia Brazil Japan Korea Mexico Singapore Spain United Kingdom United States Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 1019763_FM_VOL-I.qxp 9/17/07 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 S 50 R 51 4:22 PM Page viii This page was intentionally left blank 1st Pass Pages This is an electronic version of the print textbook. Due to electronic rights restrictions, some third party content may be suppressed. Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. The publisher reserves the right to remove content from this title at any time if subsequent rights restrictions require it. For valuable information on pricing, previous editions, changes to current editions, and alternate formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest. Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Fraud Examination, Fourth Edition W. Steve Albrecht Chad O. Albrecht Conan C. Albrecht Mark F. Zimbelman VP/Editorial Director: Jack W. Calhoun Editor-in-Chief: Rob Dewey Sr. Acquisitions Editor: Matt Filimonov Associate Developmental Editor: Julie Warwick Editorial Assistant: Ann Mazzaro Marketing Manager: Natalie Livingston Marketing Coordinator: Nicole Parsons Content Project Management: PreMediaGlobal Sr. Manufacturing Buyer: Doug Wilke Production House/Compositor: PreMediaGlobal 2012, 2009 South-Western, Cengage Learning ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may be reproduced, transmitted, stored, or used in any form or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, Web distribution, information networks, or information storage and retrieval systems, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the publisher. 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To learn more about South-Western, visit www.cengage.com/South-Western Purchase any of our products at your local college store or at our preferred online store www.cengagebrain.com Printed in the United States of America 1 2 3 4 5 6 7 15 14 13 12 11 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. To LeAnn, Jenny, Laurel, and Karen Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Brief Contents About the Authors xii Foreword xv Preface xvii PART 1 Introduction to Fraud 1 1 The Nature of Fraud 3 2 Why People Commit Fraud 31 3 Fighting Fraud: An Overview 69 PART 2 Fraud Prevention 99 4 Preventing Fraud 101 PART 3 Fraud Detection 133 5 Recognizing the Symptoms of Fraud 135 6 Data-Driven Fraud Detection 167 PART 4 7 8 9 10 Fraud Investigation 207 Investigating Theft Acts 209 Investigating Concealment 231 Conversion Investigation Methods 251 Inquiry Methods and Fraud Reports 275 PART 5 Management Fraud 355 11 Financial Statement Fraud 357 12 Revenue- and Inventory-Related Financial Statement Frauds 399 13 Liability, Asset, and Inadequate Disclosure Frauds 445 PART 6 14 15 16 17 Other Types of Fraud 501 Fraud against Organizations 503 Consumer Fraud 529 Bankruptcy, Divorce, and Tax Fraud 565 Fraud in E-Commerce 601 PART 7 Resolution of Fraud 619 18 Legal Follow-Up 621 Appendix Financial Statement Fraud Standards 641 Bibliography 648 Glossary 652 Index 664 iv Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xvii PART 1 Introduction to Fraud CHAPTER 1 The Nature of Fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Seriousness of the Fraud Problem 4 What Is Fraud? 6 Fraud, Greed, Deception, and Confidence 8 Types of Fraud 9 Employee Embezzlement 10 Vendor Fraud 11 Customer Fraud 11 Management Fraud 11 Investment Scams and Other Consumer Frauds Debates 16 17 25 28 28 56 Case Studies 63 Internet Assignment Debate 65 CHAPTER 3 Knowing Different Ways That Organizations Fight Fraud 70 Fraud Prevention 71 Creating a Culture of Honesty and High Ethics 71 Assessing and Mitigating the Risk of Fraud 75 77 Fraud Investigation 79 Approaches to Fraud Investigation 80 Conducting a Fraud Investigation 81 CHAPTER 2 Why People Commit Fraud . . . . . . . . . . . . . . . . . . . . 31 The Fraud Triangle 65 65 End Notes Fraud Detection 28 Who Commits Fraud 55 56 Fighting Fraud: An Overview . . . . . . . . . . . . . . . . . . 69 20 End Notes 51 Short Cases 58 Short Cases 23 Internet Assignments 49 Summary of the Fraud Triangle Questions 20 Case Studies The Element of Rationalization Key Terms Review of the Learning Objectives 19 Questions The Element of Opportunity 39 Controls That Prevent and/or Detect Fraudulent Behavior 39 Summary of the Controls That Prevent or Detect Fraud 44 Inability to Judge the Quality of Performance 45 Failure to Discipline Fraud Perpetrators 46 Lack of Access to Information 47 Ignorance, Apathy, and Incapacity 47 Lack of an Audit Trail 48 Review of the Learning Objectives 12 How to Prepare to Be a Fraud-Fighting Professional Certified Fraud Examiners 17 Academic Requirements 17 Professional Requirements 17 Key Terms 38 Fraud Recruitment 53 Power 53 Criminal and Civil Prosecution of Fraud 13 Criminal Law 14 Civil Law 15 Fraud-Related Careers Work-Related Pressures Other Pressures 38 33 34 The Element of Pressure 36 Financial Pressures 36 Vice Pressures 37 Follow-Up Legal Action Civil Action 83 Criminal Action 83 82 Review of the Learning Objectives Key Terms Questions 84 85 85 v Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. vi Contents Short Cases 88 Irregularities in Source Documents Faulty Journal Entries 140 Inaccuracies in Ledgers 141 89 Case Studies Internet Assignments 91 Internal Control Weaknesses 143 Debates 92 End Notes Analytical Fraud Symptoms 144 92 Unusual Behaviors PART 2 Fraud Prevention CHAPTER 4 Preventing Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101 Just About Everyone Can Be Dishonest Eliminating Opportunities for Fraud to Occur 113 Having a Good System of Internal Controls 113 Discouraging Collusion between Employees and Others and Alerting Vendors and Contractors to Company Policies 116 Monitoring Employees and Having a Whistle-Blowing System 117 Creating an Expectation of Punishment 119 Conducting Proactive Fraud Auditing 119 Preventing FraudA Summary 120 A Comprehensive Approach to Fighting Fraud 120 Organizations and FraudThe Current Model 121 124 159 Key Terms Questions 159 Short Cases 161 163 Case Studies 165 Internet Assignments End Notes 165 CHAPTER 6 Data-Driven Fraud Detection . . . . . . . . . . . . . . . . . . 167 Anomalies and Frauds 168 Audit Sampling and Fraud 169 The Data Analysis Process 169 Step 1: Understand the Business 169 Step 2: Identify Possible Frauds That Could Exist Step 3: Catalog Possible Fraud Symptoms 171 Step 4: Use Technology to Gather Data about Symptoms 171 Step 5: Analyze Results 172 Step 6: Investigate Symptoms 172 Short Cases 126 129 Internet Assignments 130 Debates 131 131 PART 3 Fraud Detection 172 Data Analysis Techniques 175 Data Preparation 175 Digital Analysis 175 Outlier Investigation 179 Stratification and Summarization Time Trend Analysis 180 Fuzzy Matching 181 179 182 CHAPTER 5 Real-Time Analysis Recognizing the Symptoms of Fraud . . . . . . . . . . . 135 Analyzing Financial Statement Reports Symptoms of Fraud 170 Data Access 173 Open Database Connectivity 173 Text Import 174 Hosting a Data Warehouse 174 Questions 125 End Notes Tips and Complaints 151 Company Employees Are in the Best Position to Detect Fraud 152 Tips and Complaints Are Fraud Symptoms 152 New Laws Protect Whistle-Blowers and Promote Fraud Detection 153 Data Analysis Software 125 Case Studies 149 Review of the Learning Objectives 158 103 Creating a Culture of Honesty, Openness, and Assistance 103 Hiring Honest People and Providing Fraud Awareness Training 103 Creating a Positive Work Environment 106 Implementing Employee Assistance Programs (EAPs) 112 Review of the Learning Objectives 148 Extravagant Lifestyles APPENDIX A: Red Hat Code of Business Conduct and Ethics 93 Key Terms 139 137 Accounting Anomalies 139 183 Review of the Learning Objectives 190 Key Terms 190 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents Conversion Investigation Methods . . . . . . . . . . . . . 251 193 Short Cases Conversion Searches 196 Case Studies Internet Assignments Debates CHAPTER 9 191 Questions 202 202 202 End Notes APPENDIX A: Examples of the Data-Driven Approach 203 PART 4 Fraud Investigation Private Sources of Information Investigating Theft Acts . . . . . . . . . . . . . . . . . . . . . . . 209 210 Theft Act Investigative Methods 212 Developing a Vulnerability Chart 213 Surveillance and Covert Operations 214 Invigilation 216 Physical Evidence 218 Electronic Evidence 218 Forensic Software Packages 221 E-mail Systems 221 A Comprehensive Example of Using Theft Act Investigation Methods 222 Review of the Learning Objectives 224 224 225 Questions 226 Short Cases 229 Case Studies Internet Assignments Debates 230 230 230 End Notes CHAPTER 8 Investigating Concealment . . . . . . . . . . . . . . . . . . . . . 231 Concealment Investigative Methods 233 Aspects of Documentary Evidence 233 Obtaining Documentary Evidence 237 Audits 237 Document Experts 242 Review of the Learning Objectives 246 246 Key Terms 246 Questions 248 Short Cases 249 Case Studies Internet Assignments Debates 250 End Notes 257 258 Online Databases 260 The Net Worth Method 261 Review of the Learning Objectives CHAPTER 7 Key Terms 253 Government Sources of Information 254 Federal Sources 254 State Sources of Information 255 County and Local Records 256 Internet Search When to Investigate 250 vii 250 Key Terms 263 264 264 Questions Short Cases 266 Case Studies 270 Internet Assignments Debates 272 272 End Notes 273 CHAPTER 10 Inquiry Methods and Fraud Reports. . . . . . . . . . . . 275 InterviewingAn Overview 276 Characteristics of a Good Interview 276 Characteristics of a Good Interviewer 277 Understanding Reaction to Crisis 277 Stage 1. Denial 279 Stage 2. Anger 279 Stage 3. Bargaining and Rationalization Stage 4. Depression 280 Stage 5. Acceptance 280 280 Planning an Interview 280 The Interviewer's Demeanor 281 The Language of Interviews 281 Question Typology 281 Elements of Conversation 282 Inhibitors of Communication 283 Facilitators of Communication 284 Mechanics of the Interview 285 Introductory Questions 285 Methodology 286 Informational Questions 288 Question Sequence 289 Informational Question Techniques 289 Note-Taking 289 Observing Respondent Reactions 290 Theme Development 291 Transition Methodology 291 Dealing with Resistance 292 Difficult People 292 Volatile Interviews 293 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. viii Contents Assessment Questions 294 Detecting Deception 294 Methodology of Assessment Questions 296 Closing Questions 298 Admission-Seeking Questions 299 Steps in the Admission-Seeking Interview 300 Refute Alibis 303 Motive for the Fraud 305 Others Involved 306 Physical Evidence 306 Specifics of Each Offense 307 Signed Statements 307 Key Points in Signed Statements 308 Honesty Testing 308 Pencil-and-Paper Test 309 Graphology 309 Voice Stress Analysis and Polygraphs The Fraud Report Key Terms A Framework for Detecting Financial Statement Fraud 368 Management and the Board of Directors 370 Managements' Backgrounds 370 Managements' Motivations 371 Managements' Influence in Making Decisions for the Organization 371 Relationships with Others 372 Relationship with Financial Institutions Relationship with Lawyers Relationship with Investors 309 373 374 374 Relationship with Regulatory Bodies Organization and Industry 310 374 376 Financial Results and Operating Characteristics 311 Questions 311 Review of the Learning Objectives 379 Short Cases 313 Key Terms Case Studies 316 Questions Internet Assignments 318 Short Cases Debates 318 Case Studies End Notes 320 Debates 377 379 380 382 383 Internet Assignments 318 APPENDIX A: Sample Signed Statement 319 APPENDIX B: An Example Fraud Report 373 Relationship with Related Organizations and Individuals 373 Relationship with Auditors 309 Review of the Learning Objectives Motivations for Financial Statement Fraud 367 387 387 End Notes 388 APPENDIX A: Recent Laws and Corporate Governance Changes Following the Sarbanes-Oxley Act 389 PART 5 Management Fraud CHAPTER 12 CHAPTER 11 Financial Statement Fraud . . . . . . . . . . . . . . . . . . . . . 357 The Problem of Financial Statement Fraud 359 Financial Statement Fraud in Recent Years 359 Why These Problems Occurred 360 Element 1: A Booming Economy 361 Element 2: Decay of Moral Values 361 Element 3: Misplaced Incentives 361 Element 4: High Analysts' Expectations 361 Element 5: High Debt Levels 362 Element 6: Focus on Accounting Rules Rather Than Principles 362 Element 7: Lack of Auditor Independence 362 Element 8: Greed 363 Element 9: Educator Failures 363 Nature of Financial Statement Fraud 364 Financial Statement Fraud Statistics 364 Phar-Mor: An Example of Financial Statement Fraud 366 Revenue- and Inventory-Related Financial Statement Frauds . . . . . . . . . . . . . . . . . . . . . . . . . . . 399 Revenue-Related Fraud 400 Acceptable Alternatives 401 Ease of Manipulating Net Income Using Revenues and Receivables 401 Identifying Revenue-Related Fraud Exposures 402 Identifying Revenue-Related Fraud Symptoms 404 Actively Searching for Revenue-Related Fraud Symptoms 406 Actively Searching for Revenue-Related Analytical Symptoms 407 Actively Searching for Accounting or Documentary Symptoms 410 Actively Searching for Control Symptoms 411 Actively Searching for Behavioral or Verbal and Lifestyle Symptoms 412 Actively Searching for Tips and Complaints 413 Following Up on Revenue-Related Fraud Symptoms 413 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents Inventory and Cost of Goods Sold Frauds 414 Identifying Inventory-Related Fraud Exposures 415 Identifying Inventory-Related Fraud Symptoms 416 Proactively Looking for Inventory-Related Fraud Symptoms 418 Searching for Inventory and Cost of Goods Sold Analytical Symptoms 419 Actively Searching for Accounting or Documentary Symptoms 422 Actively Searching for Inventory-Related Control Symptoms 422 Actively Searching for Behavioral or Verbal and Lifestyle Symptoms 422 Actively Searching for Tips and Complaints 422 Review of the Learning Objectives 423 423 Key Terms 424 Questions 427 Short Cases 431 Case Studies Internet Assignments Debates 433 434 End Notes 434 APPENDIX A: Strategic Reasoning and Detecting Revenue- and Inventory-Related Fraud 435 CHAPTER 13 Liability, Asset, and Inadequate Disclosure Frauds . 4. 45 Understating Liabilities 446 Ways to Manipulate Liabilities 447 Identifying Understatement of Liability Fraud Exposures 448 Understating Accounts Payable 448 Understating Accrued Liabilities 449 Recognizing Unearned Revenue (Liability) as Earned Revenue 450 Underrecording Future Obligations 450 Not Recording or Underrecording Various Types of Debt (Notes, Mortgages, etc.) 451 Omission of Contingent Liabilities 451 Detecting Understatement of Liability Fraud Symptoms 451 Analytical Symptoms 452 Accounting or Documentary Symptoms 452 Proactively Searching for Symptoms Related to the Underreporting of Liabilities 453 Focusing on Changes in Recorded Balances from Period to Period 453 Focusing on Changes in Relationships from Period to Period 454 Comparing Financial Statement Information with Other Companies 454 ix Comparing Financial Statement Amounts with Assets They Are Supposed to Represent or with Nonfinancial Statement Factors 456 Actively Searching for \"Accounting and Documentary\" Symptoms 456 Overstatement of Asset Fraud 456 Identifying Asset Overstatement Fraud 458 Improper Capitalization of Costs as Assets That Should Be Expensed in the Current Period 458 The Slippery Slope of Earnings Management 459 Inflated Assets through Mergers and Acquisitions (or Restructuring) or by Manipulating Intercompany Accounts and/or Transactions 459 Overstatement of Fixed Assets (Property, Plant, and Equipment) 462 Cash and Short-Term Investment Fraud 462 Overstatement of Accounts Receivable (Not Related to Revenue Recognition) or Inventory (Not Related to Cost of Goods Sold) 463 Summary of Overstatement of Asset Fraud Exposures 463 Identifying and Actively Searching for Asset Overstatement Fraud Symptoms 463 Inappropriately Capitalizing Costs That Should Be Expensed 464 Overstating Assets through Mergers, Acquisitions, or Restructurings or Manipulating Intercompany Accounts or Transactions 466 Overstatement of Cash and Short-Term Investments (Including Marketable Securities) 468 Overstatement of Receivables and/or Inventory (Not Revenue- or Cost of Goods Sold-Related) 469 Inadequate Disclosure Fraud 469 Kinds of Disclosure Fraud 470 Misrepresentations about the Nature of the Company or Its Products 470 Misrepresentations in MD&A and Other Nonfinancial Information in Financial Reports 471 Misleading Footnote Disclosures 471 Detecting Inadequate Disclosure Fraud 472 Symptoms Related to Overall Misrepresentation about the Company or Its Assets 473 Disclosure Fraud Related to Financial Reports and Financial Statement Footnotes 474 Other Types of Financial Statement Fraud 475 Inappropriate Accounting for Nonmonetary Transactions 475 Inappropriate Accounting for Roundtrip Transactions 475 Improper Accounting for Foreign Payments in Violation of the Foreign Corrupt Practices Act (FCPA) 476 Improper Use of Non-GAAP Financial Measures 476 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. x Contents Improper Use of Off-Balance-Sheet Arrangements Review of the Learning Objectives Key Terms 476 477 478 Questions 478 Short Cases 481 Internet Assignments 488 Key Terms Debates 488 Questions End Notes 556 Internet Assignments Debates PART 6 Other Types of Fraud Bankruptcy, Divorce, and Tax Fraud . . . . . . . . . . . 565 Fraud against Organizations. . . . . . . . . . . . . . . . . . . . 503 505 Asset Misappropriations 506 Theft of Cash through Larceny 507 Theft of Cash through Skimming 508 Cash Theft through Fraudulent Disbursements Theft of Inventory and Other Assets 514 Corruption 516 Bribery 516 Conflicts of Interest 518 Economic Extortion and Illegal Gratuities Review of the Learning Objectives 508 519 520 520 Questions 520 522 Debates 526 526 CHAPTER 15 Consumer Fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 529 Consumer Fraud and Its Seriousness Overview of Tax, Divorce, and Bankruptcy Frauds 566 Fraud Examiners' Roles in Bankruptcy and Divorce Cases 566 Tax Fraud 567 Fraud and the Criminal Investigation Division CI Investigative Careers 571 Divorce Fraud 571 Participants in Divorce Cases 568 572 Bankruptcy Fraud 572 The Bankruptcy Code 574 Civil and Criminal Bankruptcy Fraud Statutes 574 Civil Bankruptcy Statutes 575 Participants in the Bankruptcy Process 576 Fraud Investigator's Relationship to Participants in Bankruptcy Proceedings 578 Bankruptcy and Divorce Fraud SchemesThe Planned Bankruptcy (Bust-Out) 579 525 Internet Assignments 526 End Notes 562 CHAPTER 16 CHAPTER 14 Case Studies 562 562 End Notes Short Cases 558 Cases Studies 560 APPENDIX A: Strategic Reasoning and Detecting Liability, Asset, and Inadequate Disclosure Frauds 490 Key Terms 556 Short Cases 489 Fraud Statistics 543 Review of the Learning Objectives 555 485 Case Studies Other Types of Consumer and Investment Scams Foreign Advance-Fee Scams 543 Work-at-Home Schemes 545 Bogus Mystery Shopping Scams 549 Telemarketing Fraud 549 Investment Scams 553 530 Identity Theft 531 How Identity Theft Occurs 532 How Fraudsters Convert Personal Information to Financial Gain 534 Stealing a Victim's Identity 535 Minimizing the Risk 536 Prosecution of Identity Theft 539 Once Identity Theft Has Occurred 540 Identity TheftConcluding Comments 541 Fraudulent Concealment of Assets or Income in Bankruptcies or Divorces 580 The Debtor's or Divorcee's Estate 580 Bankruptcy Statutes Concerning Concealment of Assets 580 Means of Concealing Assets or Income 581 Indicators of Concealment 581 Fraudulent Transfers 581 Civil Liability for False Accusations 582 Money Laundering 582 The Money Laundering Process 583 Efforts to Combat Money Laundering 583 Detecting Money Laundering Schemes 583 Review of the Learning Objectives 585 Key Terms Questions 586 586 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents 592 Case Studies Internet Assignments End Notes State Courts 622 Federal Courts 623 Civil and Criminal Fraud Trials 588 Short Cases 593 593 APPENDIX A: Affidavit of Proposed Investigator 594 APPENDIX B: Application for Retention of Investigator 598 CHAPTER 17 Fraud in E-Commerce . . . . . . . . . . . . . . . . . . . . . . . . . 601 Fraud Risks in E-Commerce 603 E-Commerce Risks Inside Organizations 603 E-Commerce Risks Outside Organizations 606 Preventing Fraud in E-Commerce 607 The Control Environment 608 Risk Assessment 609 Preventing Fraud through Control Activities 609 Being an Expert Witness 631 Review of the Learning Objectives 612 Key Terms Questions 633 Short Cases 635 Case Studies 638 Short Cases 614 End Notes 633 634 Questions 612 Cases Studies 625 Overview of the Criminal Litigation Process 628 Filing Criminal Charges 628 Arresting and Charging the Defendant 628 Preliminary Hearings 628 Grand Jury 629 Arraignment 629 Discovery 629 Pretrial Motions 629 Trial and Appeal 630 Detecting E-Business Fraud 611 612 624 Overview of the Civil Litigation Process Investigation and Pleadings 625 Discovery 625 Settlement Negotiations 627 Trial and Appeal 627 Review of the Learning Objectives Key Terms xi Internet Assignments 615 Debates 617 End Notes PART 7 Resolution of Fraud CHAPTER 18 Legal Follow-Up. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621 The Court System 639 640 640 Appendix Financial Statement Fraud Standards . . . 641 Bibliography . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 648 Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 652 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 664 622 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. About the Authors W. Steve Albrecht is a professor of Accountancy in the Marriott School of Management and Andersen Alumni Professor at Brigham Young University. Dr. Albrecht, a certified public accountant (CPA), certified fraud examiner (CFE), and certified internal auditor (CIA), came to BYU in 1977 after teaching at Stanford and at the University of Illinois. He served as both associate dean of the Marriott School and as the director of the School of Accountancy and Information Systems at BYU. Dr. Albrecht received a bachelor's degree in accounting from Brigham Young University and his MBA and PhD degrees from the University of Wisconsin. He is past President of the American Accounting Association, the Association of Certified Fraud Examiners (ACFE), and Beta Alpha Psi. He was a former member of the Board of Regents of the Institute of Internal Auditors and served on the task force of the AICPA that wrote SAS 82, a fraud auditing standard, and on the FASAC, an advisory committee to the FASB. He was a member of the Committee of Sponsoring Organizations (COSO) from 1997 to 2000 and the AICPA Council from 2000 to 2003 and was chair of the AICPA's Pre-Certification Executive Education Committee from 2002 to 2004. He previously served as a trustee of the Financial Accounting Foundation that oversees the FASB and GASB. Dr. Albrecht has done extensive research on business fraud. His research has resulted in the publication of over one hundred articles in professional and academic journals. He is the author or co-author of over 20 books or monographs, several of which are on fraud. His financial and principles of accounting textbooks are in their 11th editions. In 1997, 2001, 2002 and 2003, and 2004 he was chosen as one of the 100 most influential accounting professionals in the United States by Accounting Today magazine. Because of his extensive work with the ACFE, one of the headquarters buildings in Austin, Texas is named after him. Dr. Albrecht has consulted with numerous organizations, including Fortune 500 companies, major financial institutions, the United Nations, FBI, and other organizations, and has been an expert witness in some of the largest fraud cases in America. He currently serves on the audit committees and boards of directors of two public companies. Chad O. Albrecht is an assistant professor at the Jon M. Huntsman School of Business at Utah State University. Chad has taught forensic accounting and fraud investigation at various schools both in Europe and the United States. Chad's research focuses on international fraud and corruption. This research addresses how fraud is perceived and perpetrated across cultures. Chad's xii Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. About the Authors xiii research has been published in the Journal of Business Ethics, Business and Society, Internal Auditing, Corporate Finance Review, Cross Cultural Management: An International Journal and the International Journal of Human Resource Management among others. Chad's research has been reporting in various news outlets including the prestigious Times of London. Before pursuing doctoral studies Chad worked as a licensed stockbroker for The Harris, a subsidiary of the Bank of Montreal. Chad received his bachelor's degree in accounting at Brigham Young University and his Ph.D. from ESADE Business School in Barcelona, Spain. The Wall Street Journal, Business Week and The Financial Times consistently rank ESADE as one of the top 20 business schools in the world. Conan C. Albrecht is an associate professor of Information Systems at Brigham Young University. He teaches classes in enterprise development, computer-aided fraud detection, and business programming. Dr. Albrecht researches computerbased fraud detection techniques and online group dynamics. He has published articles on fraud detection and information theory in The Journal of Forensic Accounting, The Journal of Accountancy, The Communications of the ACM, Decision Support Systems, Information and Management, and other academic and professional outlets. Dr. Albrecht received a bachelor's and master's degree in accounting from Brigham Young University and his Ph.D. in information systems from the University of Arizona. Dr. Albrecht is currently working on an open source framework for computer-based fraud detection. The core of this research is detectlets, which encode background and detection information for specific fraud schemes. In the next few years, he hopes the system will serve as the foundation of a large, online repository of detectlets about all types of fraud. Mark F. Zimbelman is a professor and the Selvoy J. Boyer Fellow at Brigham Young University's (BYU) School of Accountancy. He teaches classes on auditing and fraud examination and focuses his research on auditors' detection of financial statement fraud. His research has been published in numerous academic journals including Journal of Accounting Research, The Accounting Review, Journal of Accounting Literature, Organizational Behavior and Human Decision Processes, Auditing: A Journal of Practice and Theory, Contemporary Accounting Research and Accounting Horizons. Dr. Zimbelman received his doctorate in 1996 from the University of Arizona where he completed his dissertation on SAS 82. A paper from his dissertation was honored to be one of six that were presented at the 1997 Journal of Accounting Research Conference at the University of Chicago. In 1999, he returned to that conference to present another paper on fraud. In addition to his academic research on fraud, Dr. Zimbelman has worked with the American Institute of Certified Public Accountants and the Institute of Internal Auditors in writing various publications on fraud. Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xiv About the Authors After graduating from BYU's accounting program in 1984, Dr. Zimbelman received his CPA license and worked for over six years as a financial statement auditor and, later, as a controller in industry. After getting his Ph.D. and working for three years at the University of Oklahoma, he returned to BYU in 1999. In 2005, he took a leave of absence to work with KPMG in their fraud and forensics practice. This opportunity gave him hands on experience investigating violations of the Foreign Corrupt Practices Act, financial statement fraud, vendor fraud and embezzlement. Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Foreword According to the Association of Certified Fraud Examiners' 2010 Report to the Nations on Occupational Fraud and Abuse, certified fraud examiners estimate that organizations lose, on average, about 5 percent of their revenues to dishonesty from within. If multiplied by the estimated Gross World Product, the cost of occupational fraud and abuse may run a staggering $2.9 trillion annually. By the breadth of the definition, it covers all corporate dishonestyfrom the mailroom to the boardroom. While executives are \"cooking\" the company's earnings to show better profits, purchasing agents are getting kickbacks from suppliers, and employees are embezzling money to improve their lifestyles. Knowing how much fraud actually costs is an impossible task. The cases we know about only represent the tip of the iceberg; those discovered tend to be greedy or careless. Executives and employees who are neither may well commit fraud throughout their entire careers and get away with it. The huge cost of occupational fraud begs an obvious question: Why does it occur? The answers aren't always easy. Although the simple explanation is greeda natural human traiteven greedy people don't always lie, cheat, and steal. A more complete answer for corporate dishonesty involves three factors: the individual, the workplace, and society. Individuals likely to commit occupational fraud are often on the financial ropes. This can occur when people spend more money than they make or when there is a personal financial crisis demanding immediate resolution. Although many of us have had such difficult situations, dishonest employees are more likely to salve their consciences with rationalizations that justify fraud. In short, they lack the convictions of their own ethics. Workplace environments also contribute to occupational fraud. Organizations that are viewed by employees as uncaring, stingy, or dishonest can run a much higher risk of being victimized from within. Many workersin an attempt to right what they consider to be corporate wrongs may address these perceived injustices in a variety of ways: goldbricking, excessive absences, pilferage, and dishonesty. Moreover, some entities unwittingly contribute to the problem. By failing to establish reasonable workplace conditions, safeguards, and controls, companies might make fraud too easy, and thus too tempting. Organizations have a duty to help keep the workforce honest. Societal conditions also influence the rate of occupational fraud. If dishonesty is easily accepted and goes largely unpunished, we can only expect it to thrive. It was my own search for answers to occupational fraud twenty years ago that led me to W. Steve Albrecht. In the early 1980s, after ten years with the FBI, I practiced as a fraud examiner. Increasingly, my corporate clients were referring me cases of embezzlement, corruption, and other misdeeds. One client, certainly on the cutting-edge at the time, wanted help in developing an antifraud program. That request led me to the vast libraries of the University of Texas at Austin, where I discovered one of Dr. Albrecht's first published works on the subject, Deterring Fraud: The Internal Auditor's Perspective. After reading this seminal research by Steve and his colleagues, I sought him out personally. Even though Steve had never heard my name, he graciously invited me to Brigham Young University, where he was teaching. Dr. Albrecht answered my questions and volunteered his valuable time to aid on the topic of occupational fraud. After that, we've always stayed in touch. Neither of us then could have imagined the paths our lives would take together. In 1988, Steve xv Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xvi Foreword was a major influence in encouraging me to start the Association of Certified Fraud Examiners, and he served with distinction as its first president. Since that time, the ACFE has grown to the world's largest antifraud organization with nearly 60,000 members in over 140 countries. Steve's lifetime of contributions to the field of fraud detection and deterrence simply cannot be overstated. The ACFE recognized the enormity of Dr. Albrecht's body of work in 1998 when it honored him with its most valued prize: the Cressey Award. However, the many awards Steve has received do not capture the kind of man he is. A devoted father and husband, Steve lives his life by high example. Regardless of his many accomplishments, you won't hear about them from him; humility is one of his most endearing traits. I have had the pleasure of meeting the co-authors, Conan and Chad Albrecht, two of Dr. Albrecht's sons. There is no question that they will carry on his work. I am proud to call Steve my great friend. Steve and I are of a common mind when it comes to fraud. First, the accounting community, which has the lion's share of responsibility to control occupational fraud, is ill-equipped for the job. Second, education is the cornerstone to preventing fraud. The more we know, the less likely we are to become victims. The terms \"fraud examination\" and \"forensic accounting\" are often used interchangeably. However, they refer to different but overlapping concepts. The latter phrase, although highly popular as a euphemism for fraud investigation, actually refers to any kind of accounting work done for litigation purposes. According to the Fraud Examiners Manual, fraud examination is a methodology for resolving allegations of fraud from inception to disposition. The process involves gathering evidence, taking statements, writing reports, and assisting in the detection and deterrence of fraud. Although many organizations employ fraud examiners, audit professionals and others also conduct fraud examinations on a limited, as-needed basis. The fraud examination field draws its common body of knowledge from four areas: accounting and auditing, fraud investigation techniques, the legal elements of fraud, and criminology and ethics. Steve's work in helping define this field was indispensable. For accountants, antifraud education has been practically nonexistent for decades. One of the main reasons has been the lack of authoritative texts on the subject. Educators and students alike will find Fraud Examination to be a solution. Packed full of real examples, thought-provoking discussion issues and questions, this book is ideal for both undergraduate and graduate students. Moreover, practitioners will find a great deal of guidance in resolving current cases. Managers and executives will benefit from understanding the myriad of issues that can assist them in deterring occupational fraud. And for all of us, Fraud Examination is simply a wonderfully engaging read. Dr. Joseph T. Wells, CFE, CPA Chairman of the Board of Directors The Association of Certified Fraud Examiners Austin, Texas jwells@acfe.com http://www.acfe.com/home.asp Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface Fraud examination (sometimes called forensic accounting) is one of the most exciting careers for students studying accounting and business today. The AICPA has called forensic accounting one of the hot new \"sizzling\" career areas in accounting. It is estimated that there will be a shortage of between 25,000 and 50,000 security professionals in the next few years in the United States. Exciting opportunities for accounting and business students who become knowledgeable in fraud prevention, detection, and investigation abound in various federal agencies, such as the FBI and Postal Inspectors, major corporations, and professional service and consulting firms. Both the size and the number of frauds are increasing, which will result in an even greater demand for fraud-fighting professionals in the future. You've probably heard about Enron, WorldCom, Madoff, and other major frauds. But, there are many other types of frauds that occur every day. Fraud is an extremely costly business problem. For example, not long ago a Fortune 500 automaker experienced a $436 million fraud. Because the fraud reduced the company's net income by $436 million from what it would have been and because the company had a profit margin (net income divided by net sales) of approximately 10 percent, the company would have to generate an additional $4.36 billion (10 times the amount lost in the fraud) in revenues to restore net income to its pre-fraud level. If you assume that an average car sells for $30,000, this company would have to make and sell over 145,000 additional cars ($4.36 billion divided by $30,000 sales price) to recover the effect on net income. In other words, this company faced a major business problem: it could either make and sell 145,000 more cars, or it could work hard to prevent these types of frauds from occurring in the future. When faced with the choice of generating that much additional revenuewhich would have been difficult if not impossiblethe company decided that reducing and eliminating future frauds was the more effective way to spend its money. As a result, it hired additional fraud and control experts and implemented extensive fraud prevention procedures throughout the organization. Eliminating fraud is a problem that every organization faces, and you can help them deal with this growing problem. Even if you decide not to become a fraud expert, the topics you will study in this book will help you be a better professional in whatever career path you choose. The technology, interviewing, document examination, public records, and other tools and knowledge you will gain will make you a better consultant, auditor, tax professional, or manager, as well as a better and more astute investor. As you will discover in this book, there is a very active professional organization that deals with fighting fraud called the Association of Certified Fraud Examiners (ACFE), which currently has over 40,000 members and is based in Austin, Texas. This organization, as well as others, can provide future fraud training. In addition, the ACFE will provide its educational materials free of charge to institutions of higher learning that agree to offer a three-hour course entitled \"Fraud Examination.\" These materials include several original videos related to fraud detection and prevention. A complete listing of the ACFE's materials and other information can be found at the Association's Web site at www. acfe.com. New To This Edition For our fourth edition, we have added enhancements and updates that will help you better understand the significance of fraud in the modern xvii Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xviii Preface business world. In this revision, there has been a significant amount of changes to each chapter: In Part 1 of the textbook, we introduce students to new frauds such as the Madoff Scandal in Chapter 1. All chapters in Part 1 have introduced new references, inserted additional learning objectives, updated all statistics (including information about the COSO report in Chapter 2), added a new section on the ACFE, added additional end-of-chapter questions, and overall increased readability and layout of each chapter in the first part of the book. Also, the Red Hat section in Chapter 3 has been moved to create Appendix A. Part 2 and Part 3 of the textbook also contains new learning objectives, new references, new statistics and increased readability and layout of the chapters. Chapter 6 contains new updates to reflect the current state of technology and software packages. The technology assignments in Chapter 6 have been revised to be compatible with the student version of ACL. Chapters 7-10 in Part 4 contain information on the most recent software for detecting fraud, updates to the public record search sites, and we updated the FBI information with the most recent data available. All chapters have also undergone significant changes to certain sections to improve readability. As with the previous chapters, additional end-of-chapter questions and references have also been added. Part 5 contains new cases and has changed the main fraud case from Rite Aid to Enron in order to present students with a more widelyknown financial statement fraud case. It also contains a discussion of the subprime lending crisis, Lehman Brothers and the Satyam frauds and provides more current evidence of the problem of financial statement fraud. Chapter 17 contains new examples from recent events and surveys. This chapter also discusses changes in technology which present new challenges to fraud detection and prevention. New cases help students familiar with mobile platforms and social networks see fraud from these perspectives. Overall, the textbook contains several new cases that detail recent frauds and many of the former cases were re-worked in order to make them more understandable for students. Featured Topics by Chapter In this book, we cover seven different topics: Part 1, comprising Chapters 1, 2, and 3, provides an introduction to fraud and an overview of the fraud problem. Chapter 1 discusses the nature of fraud, Chapter 2 describes fraud perpetrators and their motivations for being dishonest, and Chapter 3 provides an overview of the different ways to fight and, hopefully, reduce fraud. The second and third parts of the book focus on fraud prevention (Chapter 4) and fraud detection (Chapters 5 and 6.) Chapter 5 provides an overview of and discusses traditional fraud detection methods, while Chapter 6 introduces you to the use of technology to proactively detect fraud. Part 4 covers the various elements of fraud investigation. In Chapter 7, we cover theft act investigation methods; in Chapter 8, we cover concealment investigation methods; in Chapter 9, we discuss conversion investigative methods; and in Chapter 10, we cover various types of interviewing and other query approaches to investigating fraud. The interview techniques you learn in Chapter 10 will make you a more discerning husband or wife, parent, manager, employee, or friend. Parts 5 and 6 discuss the various types of fraud. In Part 5, we include three chapters on management, or financial statement, fraud. In Chapter 11, we provide an overview of financial statement fraud and introduce a proactive model for detecting fraud and errors in the financial statements. In Chapter 12, we discuss both revenue- and inventory-related frauds, the two most common ways to intentionally misstate financial statements. In Chapter 13, we discuss three other types of financial statement frauds: understating liabilities and expenses, overstating assets, and inadequate Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface disclosures. These chapters will help you better understand and critique the financial statements of any organization. In Part 6, we discuss four other types of fraud. Chapter 14 covers fraud committed against organizations by employees, vendors, and customers. Chapter 15 covers consumer fraud, a chapter that will have immediate relevance to you and will alert you to the fraud exposures you face every day. Chapter 16 introduces divorce, tax and bankruptcy fraud, all of which are very common because people often try to hide assets from those who want to take them awaythe government in the case of taxes and others in the cases of divorce and bankruptcy. Chapter 16 also covers money laundering frauds. Chapter 17 discusses e-Business frauds, a growing type of fraud problem because of the increasing use of the Internet to conduct business. The final part in the bookChapter 18 discusses options that victims have when deciding how to follow-up on frauds they experience. This chapter provides an overview of the criminal and civil statutes governing fraud legal proceedings and helps you understand the various ways organizations have to resolve dishonest acts. xix We realize that there are many other fraud-related topics that we could have included. We have tried to strike a balance between brevity and topics of general interest and detailed investigation and specific knowledge that experienced professional fraud examiners would need. We also realize that, for most of you, this book will be used in the only fraud-related course you will take in your college studies. We are certain, however, that studying fraud will be one of your most exciting courses and will spark an interest that will stimulate career-changing plans for many of you. At a minimum, after studying fraud examination, you should be a much more careful investor and business decision maker. You will never view business transactions or reports the same way, and you will be a much more careful and skeptical observer and participant in future endeavors. We are excited to share this exciting topic with you. We wish you success and enthusiasm as you study this book, and we welcome suggestions for improvement. W. Steve Albrecht, Ph.D., CFE, CPA, CIA Chad O. Albrecht, D.E.A.1 Conan C. Albrecht, Ph.D. Mark F. Zimbelman, Ph.D. 1 D.E.A.Diploma de Estudios Advanzados or First Doctoral Degree. The D.E.A. is similar to the British Master of Philosophy or the French Diploma D'etudes Approfondies. Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. xx Preface Acknowledgements Several reviewers and supplemental preparers provided valuable comments that aided in the development of the 4th edition of this book. They were: Carla Allen Northwood University Sandra Augustine Hilbert College Lisa Banks Mott Community College Thane E. S. Butt Champlain College Linda Christiansen Indiana University Southeast Sandra S. Lang McKendree University Janice Lawrence University of Nebraska-Lincoln Erik Lindquist, CFE Lansing Community College Jill Christopher Ohio Northern University LuAnn Bean Florida Institute of Technology Rodney R. Michael University of North Texas David A. O'Dell McPherson College Susan E. Wright DeKalb Technical College We are very grateful for the help of many other individuals who made this book possible. Beyond the official reviewers mentioned above, professors and students from around the world sent us ideas, comments, and errors, and we appreciated the feedback. We appreciate the talented word processing help of many several secretaries and assistants at BYU. We appreciate the able and talented editing of Matt Filimonov, Julie Warwick, Jean Buttrom of Cengage South-Western as well as Divya Divakaran of PreMediaGlobal. We also appreciate Brigham Young University for its support and for providing an environment of stimulation and challenge. Joseph T. Wells, Chairman of the Association of Certified Fraud Examiners (ACFE), has been inspiring and helpful in many ways. In this area of fraud examination, he has been our closest and most supportive friend. He and the ACFE have made their materials available to us in writing this book and, through their generous offer to support fraud education, will make their videos and other materials available to professors. Joseph Wells, through his work with the ACFE, has done more to fight fraud in the United States and the world than any other person we know. We also appreciate the help of valuable colleagues with whom we have collaborated previously. Gerald W. Wernz and Timothy L. Williams were co-authors on a previous book and several academic articles from which many ideas for this book were taken. Joe Brazel, Gregory J. Dunn, Vicky Hoffman, Keith Jones, William Waller, and Jeff Wilks have been co-authors on journal articles from which ideas have been taken as well. We are also grateful to the many law firms, professional service firms, corporations, and government organizations that have provided us with consulting and expert witnessing opportunities to enrich our fraud experience and background. Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. PART 1 Introduction to Fraud 1 2 3 The Nature of Fraud 3 Why People Commit Fraud 31 Fighting Fraud: An Overview 69 1 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 1019763_FM_VOL-I.qxp 9/17/07 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 S 50 R 51 4:22 PM Page viii This page was intentionally left blank 1st Pass Pages CHAPTER 1 The Nature of Fraud LEARNING OBJECTIVES TO THE STUDENT After studying this chapter, you should be able to: With this chapter, you are embarking on an exciting journey of the study of fraud. Many of you will find this course more interesting than any other course you have taken before. Chapter 1 will provide an overview of fraud what is fraud, how serious is the problem, fraudfighting careers, criminal and civil laws, and other overview topics. Understand the seriousness of fraud and how fraud affects individuals, consumers, organizations, and society. Define fraud. Understand the different types of fraud. Understand the difference between fraud committed against an organization and fraud committed on behalf of an organization. Understand the difference between criminal and civil fraud laws. Understand the types of fraud-fighting careers available today. 3 Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 4 Part 1: Introduction to Fraud n December 11, 2008 the Federal Bureau O of Investigation (FBI) arrested Bernard \"Bernie\" Madoff for perpetrating the single largest investment fraud in the history of the world. A day earlier, Madoff's own sons had turned him in, reporting to authorities that Madoff's wealth management business was not a legitimate business but was a shell company for a large scam. While the actual amounts of the fraud are still not known, estimates suggest that the amount missing from client accounts, including fabricated gains, may be as much as $65 billion.1 Madoff was born in Queens, New York, and later graduated from Hofstra College in 1960. After college he dedicated himself to building his firm, Bernard L. Madoff Investment Securities, where he remained until his arrest in 2008. Throughout his career, Madoff became one of the most respected and trusted individuals on Wall Street, serving both as Chairman of the Board of Directors and on the Board of Governors of the NASD (National Association of Securities Dealers). Madoff was also actively engaged in creating the technology that eventually became the NASDAQ stock exchange. Madoff perpetrated his scheme by consistently providing high returns for his investors. Madoff claimed that he was able to provide such returns by investing in what is known as a split-strike conversion strategy. A split-strike conversion strategy is a complicated investment where investors take a long position in equities together with a short call and a long put on an equity index to lower the volatility of the position.2 While the entire split-strike conversion strategy may seem very elaborate, the strategy was nothing more than a tool employed by Madoff to attract additional investors to his large Ponzi scheme. A Ponzi scheme is a type of fraud that lures investment funds from victims and then pays those victims a premium or interest from money that is paid by subsequent investors.3 Without intervention, Ponzi schemes will continue to grow until new recruits become unavailable, at which time, the scam is broken down and discovered. Individuals throughout the world lost money in Madoff's pyramid scheme.4 While many of the victims were blue-collared workers that came from humble backgrounds, others were extremely wealthy. For example, Prince Michel of Yugoslavia traveled across Europe to raise money for Madoff. Other victims included various royal families and even London's House of Lords. Actor Kevin Bacon and producer Steven Spielberg, as well as various other Hollywood movie stars had invested with Madoff. Because Madoff had connections to the Jewish community, many Jewish charities and institutions lost a significant amount of money in the scam.5 Seriousness of the Fraud Problem Bernard Madoff is an example of an individual who misrepresented himself and his company to commit fraud. Investment fraud, like the fraud committed by Bernard Madoff, is just one of the many types of frauds that present major problems for businesses and consumers throughout the world. Although most people and even most researchers believe that