Fraud 101 Techniques and Strategies for Understanding Fraud Third Edition STEPHEN PEDNEAULT John Wiley & Sons, Inc Copyright © 2009 by Stephen Pedneault All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services, or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993, or via fax (317) 572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Pedneault, Stephen, 1966Fraud 101 : techniques and strategies for understanding fraud / Stephen Pedneault.–3rd ed p cm Includes bibliographical references and index ISBN 978-0-470-48196-7 (cloth) Commercial crimes–Investigation–United States Fraud investigation– United States I Title II Title: Fraud one hundred one III Title: Fraud one hundred and one HV6769.D38 2009 2009015530 363.25 963–dc22 Printed in the United States of America 10 For Justin, Evan, and Kim Contents Preface ix Acknowledgments xv Introduction xvii CHAPTER CHAPTER CHAPTER The World of Fraud Definition of Fraud The Many Types of Fraud Why Is Fraud Committed? 19 A Rationalizing Society Financial Statement Fraud Financial Fraud Comes in Different Shapes and Sizes Motivators Differ by Type of Business Employee Schemes In the End 20 22 23 25 27 32 Financial Statement Fraud Schemes 33 Where Do Things Go Wrong? Trend Analysis Beyond Traditional Audits 34 42 45 v Contents CHAPTER CHAPTER CHAPTER CHAPTER vi Employee Embezzlements 51 The Fraud Triangle Areas for Concern 55 57 Other Fraud Schemes 69 Duplicate Payment Fraud Multiple Payee Fraud Shell Fraud Defective Delivery Fraud Defective Receipt Fraud Defective Shipment Fraud Defective Pricing Fraud 71 72 73 77 88 89 91 Contract Rigging Schemes 97 Stage One: Obtaining the Contract Stage Two: Contract Change Orders Unbalanced Bidding Detection Recommendations Rotation Fraud Where Do We Go from Here? 97 102 114 118 119 121 Responses to Fraud 123 Government’s Response to Fraud Accounting Profession’s Response to Fraud Internal Audit Profession’s Response to Fraud New Credentials, More Training, Better Awareness Articles, Books, and More Resources 124 129 133 134 136 Contents CHAPTER CHAPTER CHAPTER 10 CHAPTER 11 The Importance of Internal Controls and Internal Audit 143 Why Have Internal Controls? D´ej`a Vu Good Internal Controls Internal Audit 144 148 150 152 Evidence 159 What Is Evidence? Documentation 160 163 Conducting Fraud Investigations: A Practical Approach 171 Proactive Fraud Investigations Discovery Investigations Supportive Investigations Strategy Predication The Investigative Plan Conducting the Procedures Findings Use of the Findings 171 172 175 178 180 181 183 186 188 Fraud Investigation Alternatives 189 Assessing the Feasibility of a Full Investigation Monitoring Operational Areas at Risk of Fraud Revamping Internal Controls: Closing the Barn Door Doing Nothing? 189 197 200 203 vii Contents APPENDIX A APPENDIX B APPENDIX C Index viii Vending 209 Lessons Learned 213 Living a Fac¸ade 217 Prevention Techniques 221 Disappearing Inventory 225 Internal Controls 230 231 ... Cataloging-in-Publication Data: Pedneault, Stephen, 196 6Fraud 101 : techniques and strategies for understanding fraud / Stephen Pedneault. –3rd ed p cm Includes bibliographical references and index... Fraud 101 Techniques and Strategies for Understanding Fraud Third Edition STEPHEN PEDNEAULT John Wiley & Sons, Inc Copyright © 2009 by Stephen Pedneault All rights reserved... The Fraud Triangle Areas for Concern 55 57 Other Fraud Schemes 69 Duplicate Payment Fraud Multiple Payee Fraud Shell Fraud Defective Delivery Fraud Defective Receipt Fraud Defective Shipment Fraud