Fraud Examiners Manual 2022 Edition PDF

Fraud Examiners Manual 2022 Edition Select a section below to view its chapters: Main Table of Contents...

Fraud Examiners Manual 2022 Edition Select a section below to view its chapters: Main Table of Contents Law Preface Investigation Financial Transactions Fraud Prevention and and Fraud Schemes Deterrence SEARCH Copyright and Bibliography © 2022 Association of Certified Fraud Examiners, Inc. “ACFE,” “CFE,” “Certified Fraud Examiner,” “CFE Exam Prep Course,” “Association of Certified Fraud Examiners,” “Report to the Nations,” the ACFE seal, the ACFE logo, and related trademarks, names, and logos are the property of the Association of Certified Fraud Examiners, Inc., and are registered and/or used in the U.S. and countries around the world. Fraud Examiners Manual 2022 Edition Financial Transactions and Fraud Schemes HOME FINANCIAL TRANSACTIONS AND FRAUD SCHEMES LAW INVESTIGATION FRAUD PREVENTION AND DETERRENCE SEARCH Table of Contents Asset Misappropriation: Payment Fraud Inventory and Other Assets Accounting Concepts Insurance Fraud Corruption Financial Statement Fraud Health Care Fraud Theft of Data and Intellectual Asset Misappropriation: Property Consumer Fraud Cash Receipts Identity Theft Cyberfraud Asset Misappropriation: Fraudulent Disbursements Financial Institution Fraud Contract and Procurement Fraud © 2022 Association of Certified Fraud Examiners, Inc. “ACFE,” “CFE,” “Certified Fraud Examiner,” “CFE Exam Prep Course,” “Association of Certified Fraud Examiners,” “Report to the Nations,” the ACFE seal, the ACFE logo, and related trademarks, names, and logos are the property of the Association of Certified Fraud Examiners, Inc., and are registered and/or used in the U.S. and countries around the world. Fraud Examiners Manual 2022 Edition Law HOME FINANCIAL TRANSACTIONS AND FRAUD SCHEMES LAW INVESTIGATION FRAUD PREVENTION AND DETERRENCE SEARCH Table of Contents Tax Fraud Overview of the Legal System Individual Rights During Examinations The Law Related to Fraud The Criminal Justice System Bankruptcy (Insolvency) Fraud The Civil Justice System Securities Fraud Basic Principles of Evidence Money Laundering Testifying © 2022 Association of Certified Fraud Examiners, Inc. “ACFE,” “CFE,” “Certified Fraud Examiner,” “CFE Exam Prep Course,” “Association of Certified Fraud Examiners,” “Report to the Nations,” the ACFE seal, the ACFE logo, and related trademarks, names, and logos are the property of the Association of Certified Fraud Examiners, Inc., and are registered and/or used in the U.S. and countries around the world. Fraud Examiners Manual 2022 Edition Investigation HOME FINANCIAL TRANSACTIONS AND FRAUD SCHEMES LAW INVESTIGATION FRAUD PREVENTION AND DETERRENCE SEARCH Table of Contents Sources of Information Appendix B: Fraud Examination Checklist Planning and Conducting a Data Analysis and Fraud Examination Reporting Tools Appendix C: Sample Forms Collecting Evidence Digital Forensics Appendix D: Sample Fraud Examination Reports Interview Theory and Application Tracing Illicit Transactions Appendix E: Sample Expert Interviewing Suspects and Report Writing Witness Report Signed Statements Appendix A: Engagement Covert Operations and Advisory Letters © 2022 Association of Certified Fraud Examiners, Inc. “ACFE,” “CFE,” “Certified Fraud Examiner,” “CFE Exam Prep Course,” “Association of Certified Fraud Examiners,” “Report to the Nations,” the ACFE seal, the ACFE logo, and related trademarks, names, and logos are the property of the Association of Certified Fraud Examiners, Inc., and are registered and/or used in the U.S. and countries around the world. Fraud Examiners Manual 2022 Edition Fraud Prevention and Deterrence HOME FINANCIAL TRANSACTIONS AND FRAUD SCHEMES LAW INVESTIGATION FRAUD PREVENTION AND DETERRENCE SEARCH Table of Contents Fraud Prevention Programs Understanding Criminal Behavior Fraud Risk Assessment White-Collar Crime Fraud Risk Management Corporate Governance Ethics for Fraud Examiners Management’s Fraud-Related Responsibilities ACFE Code of Professional Ethics Auditors’ Fraud-Related Responsibilities CFE Code of Professional Standards © 2022 Association of Certified Fraud Examiners, Inc. “ACFE,” “CFE,” “Certified Fraud Examiner,” “CFE Exam Prep Course,” “Association of Certified Fraud Examiners,” “Report to the Nations,” the ACFE seal, the ACFE logo, and related trademarks, names, and logos are the property of the Association of Certified Fraud Examiners, Inc., and are registered and/or used in the U.S. and countries around the world. MENU © 1990–2022 Association of Certified Fraud Examiners, Inc. The original purchaser of this volume is authorized to print one copy solely for their personal use. The original purchaser may also reproduce in any form or by any means up to 25 pages contained in this work for noncommercial or educational use. Such reproduction requires no further permission from the authors or publisher and/or payment of any permission fee as long as proper credit is given. Except as specified above, no portion of this work may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system without the written permission of the ACFE. ISBN 978-1-889277-85-1 716 West Avenue Austin, Texas 78701 United States of America (800) 245-3321/(512) 478-9000 ACFE.com DISCLAIMER No publication could cover all of the rules and regulations applicable for every country around the globe. The editors of this work have attempted to provide general information about concepts and methods of fraud detection, investigation, and prevention that are commonly used worldwide. Because this publication is a compendium of information from various countries and jurisdictions, the specific laws, rules, regulations, and terminology may (and probably will) vary in your area. Every effort has been made to ensure that the contents of this publication are accurate and free from error. However, it is possible that errors exist, both typographical and in content. Therefore, the information provided herein should be used only as a guide and not as the only source of reference. This publication is not intended to be a legal or accounting reference, and nothing contained herein is to be considered as the rendering of legal or accounting advice for specific subjects or areas. Readers are responsible for obtaining such advice from legal or accounting professionals in their jurisdictions. This publication and any forms or samples within are intended for educational and informational purposes only. Descriptions of products, software programs, organizations, service organizations, etc., are provided as a convenience to the reader. Readers are advised to obtain further information from the provider of the product or service before purchasing. The author, advisors, and publishers shall have neither liability nor responsibility to any person or entity with respect to any loss, damage, or injury caused or alleged to be caused directly or indirectly by any information contained in or omitted from this publication. MENU FRAUD EXAMINERS MANUAL TABLE OF CONTENTS VOLUME I SECTION 1 FINANCIAL TRANSACTIONS AND FRAUD SCHEMES ACCOUNTING CONCEPTS Accounting Basics........................................................................................................................ 1.101 Financial Statements.................................................................................................................... 1.105 Generally Accepted Accounting Principles.............................................................................. 1.116 FINANCIAL STATEMENT FRAUD What Is Financial Statement Fraud?.......................................................................................... 1.203 The Cost of Financial Statement Fraud.................................................................................... 1.204 Why Financial Statement Fraud Is Committed....................................................................... 1.204 Trends in Financial Statement Fraud........................................................................................ 1.206 Financial Statement Fraud Schemes.......................................................................................... 1.208 What Red Flags Are Associated with Financial Statement Fraud in General?................... 1.237 Detection of Fraudulent Financial Statement Schemes......................................................... 1.238 Financial Statement Analysis...................................................................................................... 1.240 Interviews in Fraudulent Financial Statement Cases.............................................................. 1.248 Prevention of Financial Statement Fraud................................................................................. 1.256 ASSET MISAPPROPRIATION: CASH RECEIPTS Skimming....................................................................................................................................... 1.301 Cash Larceny................................................................................................................................. 1.320 Theft of Cash on Hand............................................................................................................... 1.333 ASSET MISAPPROPRIATION: FRAUDULENT DISBURSEMENTS Register Disbursement Schemes................................................................................................ 1.401 Payment Tampering Schemes.................................................................................................... 1.410 Billing Schemes............................................................................................................................. 1.437 Payroll Fraud Schemes................................................................................................................ 1.457 Expense Reimbursement Schemes............................................................................................ 1.475 ASSET MISAPPROPRIATION: INVENTORY AND OTHER ASSETS Misuse of Inventory and Other Assets..................................................................................... 1.501 Theft of Inventory and Other Assets........................................................................................ 1.502 Misappropriation of Intangible Assets...................................................................................... 1.518 Fraud Examiners Manual: 2022 Edition i MENU FRAUD EXAMINERS MANUAL FINANCIAL TRANSACTIONS AND FRAUD SCHEMES CORRUPTION What Is Corruption?.................................................................................................................... 1.601 Forms of Corruption................................................................................................................... 1.601 Methods of Making Corrupt Payments.................................................................................... 1.609 Detection of Corruption Schemes............................................................................................. 1.611 Conflicts of Interest..................................................................................................................... 1.627 Anti-Corruption Programs......................................................................................................... 1.638 THEFT OF DATA AND INTELLECTUAL PROPERTY Competitive Intelligence Versus Espionage............................................................................. 1.702 Where Intelligence Professionals Get Information................................................................ 1.704 Favorite Employee Targets of Intelligence Professionals...................................................... 1.712 How Information Is Lost or Stolen.......................................................................................... 1.713 Electronic Countersurveillance.................................................................................................. 1.734 Insider Threats to Proprietary Information............................................................................. 1.735 Investigating Corporate Espionage........................................................................................... 1.740 Program for Safeguarding Proprietary Information............................................................... 1.742 Minimizing the Risks of Misappropriation Claims.................................................................. 1.754 IDENTITY THEFT Perpetrators of Identity Theft.................................................................................................... 1.801 Victims of Identity Theft............................................................................................................ 1.802 Methods of Committing Identity Theft.................................................................................... 1.803 Types of Identity Theft Schemes............................................................................................... 1.804 How Identity Thieves Steal Information.................................................................................. 1.808 Methods of Preventing Identity Theft...................................................................................... 1.815 How to Respond to Identity Theft............................................................................................ 1.816 FINANCIAL INSTITUTION FRAUD Embezzlement Schemes............................................................................................................. 1.901 Loan Fraud.................................................................................................................................... 1.905 Real Estate Fraud......................................................................................................................... 1.916 New Account Fraud Schemes.................................................................................................... 1.936 Money Transfer (Wire) Fraud Schemes.................................................................................... 1.940 Automated Teller Machine Fraud.............................................................................................. 1.943 Account Takeover........................................................................................................................ 1.944 Advance-Fee Fraud...................................................................................................................... 1.945 ii Fraud Examiners Manual: 2022 Edition MENU FRAUD EXAMINERS MANUAL FINANCIAL TRANSACTIONS AND FRAUD SCHEMES FINANCIAL INSTITUTION FRAUD (CONT.) Letter-of-Credit Fraud................................................................................................................. 1.947 Inside/Outside Frauds................................................................................................................ 1.947 Prevention..................................................................................................................................... 1.948 Suspicious Transaction Reports................................................................................................. 1.950 The Basel Committee on Banking Supervision....................................................................... 1.951 PAYMENT FRAUD Check Fraud.................................................................................................................................. 1.1001 Payment Card Fraud.................................................................................................................... 1.1013 Prevention and Detection of Payment Card Fraud................................................................ 1.1023 Electronic Bill Payment and Person-to-Person Payments..................................................... 1.1034 Online and Mobile Account Fraud........................................................................................... 1.1043 Alternative Currencies................................................................................................................. 1.1045 INSURANCE FRAUD Types of Insurance Policies........................................................................................................ 1.1101 Agent/Broker Fraud.................................................................................................................... 1.1102 Underwriting Irregularities.......................................................................................................... 1.1103 Vehicle Insurance Schemes........................................................................................................ 1.1105 Property Schemes......................................................................................................................... 1.1108 Life Insurance Schemes............................................................................................................... 1.1109 Liability Schemes.......................................................................................................................... 1.1109 Workers’ Compensation Fraud.................................................................................................. 1.1109 Detecting and Preventing Insurance Fraud.............................................................................. 1.1119 HEALTH CARE FRAUD Types of Health Care Systems................................................................................................... 1.1201 Provider Fraud.............................................................................................................................. 1.1205 Fraud by the Medical Staff.......................................................................................................... 1.1212 Inflated Billings............................................................................................................................. 1.1212 Kickbacks in the Health Care Industry..................................................................................... 1.1217 Fraud by Medical Institutions.................................................................................................... 1.1218 Other Frauds in the Institutional Setting.................................................................................. 1.1224 Fraud in Special Care Facilities.................................................................................................. 1.1225 Fraud by the Patient..................................................................................................................... 1.1227 Fraud by Insurance Companies................................................................................................. 1.1230 Employee Claims Fraud.............................................................................................................. 1.1232 Fraud Examiners Manual: 2022 Edition iii MENU FRAUD EXAMINERS MANUAL FINANCIAL TRANSACTIONS AND FRAUD SCHEMES HEALTH CARE FRAUD (CONT.) Agent Fraud.................................................................................................................................. 1.1234 Electronic Claims Fraud.............................................................................................................. 1.1235 Health Care Compliance Programs........................................................................................... 1.1238 CONSUMER FRAUD Consumer Fraud Schemes.......................................................................................................... 1.1301 Elder Fraud................................................................................................................................... 1.1313 Telemarketing Fraud.................................................................................................................... 1.1316 Ponzi and Pyramid Schemes...................................................................................................... 1.1334 CYBERFRAUD What Is Cyberfraud?.................................................................................................................... 1.1401 Recognizing Computer Intrusion.............................................................................................. 1.1402 Insider Threats.............................................................................................................................. 1.1404 Computer Hacking....................................................................................................................... 1.1405 Malware......................................................................................................................................... 1.1419 Email.............................................................................................................................................. 1.1432 Internet Fraud............................................................................................................................... 1.1434 Electronic Commerce and Information Security.................................................................... 1.1436 Cybersecurity................................................................................................................................ 1.1439 CONTRACT AND PROCUREMENT FRAUD Basics of Contract Law............................................................................................................... 1.1501 Methods of Procurement............................................................................................................ 1.1503 Phases in the Procurement Process........................................................................................... 1.1507 Categories of Procurement Fraud Schemes............................................................................. 1.1511 Preventing Contract and Procurement Fraud.......................................................................... 1.1534 iv Fraud Examiners Manual: 2022 Edition MENU FRAUD EXAMINERS MANUAL SECTION 2 LAW OVERVIEW OF THE LEGAL SYSTEM Basic Concepts of the Law......................................................................................................... 2.101 Types of Legal Systems............................................................................................................... 2.103 International Issues in Fraud Cases........................................................................................... 2.109 Court Systems............................................................................................................................... 2.110 Civil and Criminal Actions for Fraud........................................................................................ 2.111 Parallel Proceedings..................................................................................................................... 2.113 Administrative Proceedings........................................................................................................ 2.114 THE LAW RELATED TO FRAUD Definition of Fraud...................................................................................................................... 2.201 Principal Types of Fraud............................................................................................................. 2.201 International Initiatives Against Fraud and Corruption......................................................... 2.222 BANKRUPTCY (INSOLVENCY) FRAUD Key Parties in the Bankruptcy System...................................................................................... 2.301 Types of Bankruptcy Filings....................................................................................................... 2.304 Bankruptcy Schemes.................................................................................................................... 2.305 Cross-Border Insolvency Regimes............................................................................................ 2.308 The World Bank Principles........................................................................................................ 2.309 SECURITIES FRAUD What Constitutes a Security?...................................................................................................... 2.401 Securities Laws and Regulations................................................................................................ 2.422 Self-Regulatory Organizations.................................................................................................... 2.438 Securities Fraud Schemes............................................................................................................ 2.440 Investigative Tips......................................................................................................................... 2.455 MONEY LAUNDERING The Money Laundering Process................................................................................................ 2.501 Money Laundering Methods...................................................................................................... 2.504 International Anti-Money Laundering Efforts........................................................................ 2.529 Enforcement and Prevention Strategies................................................................................... 2.540 Special Problems for Insurance Companies............................................................................ 2.544 Fraud Examiners Manual: 2022 Edition v MENU FRAUD EXAMINERS MANUAL LAW TAX FRAUD Introduction.................................................................................................................................. 2.601 Evidence of Tax Fraud................................................................................................................ 2.604 Types of Tax Evasion Schemes................................................................................................. 2.605 Common Defenses to Allegations of Tax Evasion................................................................ 2.607 Fraud Schemes Targeting Taxpayers......................................................................................... 2.609 INDIVIDUAL RIGHTS DURING EXAMINATIONS Employees’ Duties and Rights During Investigations............................................................ 2.701 Rights and Obligations Under Criminal Law........................................................................... 2.708 The Law Relating to Government Search and Seizure........................................................... 2.714 Investigations in Private Actions............................................................................................... 2.717 THE CRIMINAL JUSTICE SYSTEM International Covenant on Civil and Political Rights............................................................. 2.801 The Charging Process.................................................................................................................. 2.803 Defenses........................................................................................................................................ 2.805 The Trial Process......................................................................................................................... 2.807 Sentencing..................................................................................................................................... 2.816 Punishment................................................................................................................................... 2.817 Appeal............................................................................................................................................ 2.818 Corporate Criminal Liability....................................................................................................... 2.819 THE CIVIL JUSTICE SYSTEM Procedure in Civil Cases............................................................................................................. 2.901 Decisions and Remedies in Civil Cases..................................................................................... 2.910 Alternative Dispute Resolution.................................................................................................. 2.912 BASIC PRINCIPLES OF EVIDENCE Three Basic Forms of Evidence.................................................................................................. 2.1002 Direct Versus Circumstantial Evidence...................................................................................... 2.1002 Admissibility of Evidence............................................................................................................. 2.1003 Special Rules Concerning the Admission of Evidence in Adversarial Proceedings............. 2.1005 Chain of Custody........................................................................................................................... 2.1024 Impeachment.................................................................................................................................. 2.1026 Privileges and Protections............................................................................................................. 2.1028 vi Fraud Examiners Manual: 2022 Edition MENU FRAUD EXAMINERS MANUAL LAW TESTIFYING Considerations for Testifying as a Lay Witness......................................................................... 2.1102 Considerations for Testifying as an Expert................................................................................ 2.1105 Qualifying to Testify as an Expert Witness................................................................................ 2.1111 Preparing to Testify....................................................................................................................... 2.1115 Direct Examination....................................................................................................................... 2.1118 Cross-Examination........................................................................................................................ 2.1123 Expressing an Opinion on Guilt.................................................................................................. 2.1130 Witness Immunity for Experts..................................................................................................... 2.1132 Summary.......................................................................................................................................... 2.1132 Fraud Examiners Manual: 2022 Edition vii MENU FRAUD EXAMINERS MANUAL VOLUME II SECTION 3 INVESTIGATION PLANNING AND CONDUCTING A FRAUD EXAMINATION Why Conduct a Fraud Examination?........................................................................................ 3.101 What Fraud Examination Entails.............................................................................................. 3.102 Fraud Examination and Forensic Accounting......................................................................... 3.104 Fraud Examination Methodology.............................................................................................. 3.104 Develop a Fraud Response Plan................................................................................................ 3.112 Initial Response to Suspicions or Allegations of Fraud......................................................... 3.116 Planning and Conducting a Formal Investigation................................................................... 3.124 Structure the Investigation to Preserve Confidentiality......................................................... 3.144 COLLECTING EVIDENCE Types of Evidence....................................................................................................................... 3.201 General Rules for Collecting Documents................................................................................ 3.202 Obtaining Documentary Evidence............................................................................................ 3.202 Examining Fraudulent Documents........................................................................................... 3.205 Handling Documents as Physical Evidence............................................................................. 3.207 Identifying Writings..................................................................................................................... 3.210 The Document Expert’s Findings............................................................................................. 3.213 How to Obtain Handwriting Samples...................................................................................... 3.214 Typewriters and Computer Printers.......................................................................................... 3.216 Photocopies.................................................................................................................................. 3.217 Dating a Document..................................................................................................................... 3.220 Indented Writings........................................................................................................................ 3.222 Counterfeit Printed Documents................................................................................................ 3.223 Fingerprints................................................................................................................................... 3.224 Disposal of Evidence................................................................................................................... 3.226 Sources for Expert Document Examinations.......................................................................... 3.227 INTERVIEW THEORY AND APPLICATION Preparation.................................................................................................................................... 3.301 Characteristics of a Successful Interview.................................................................................. 3.302 Characteristics of an Effective Interviewer.............................................................................. 3.303 Legal Considerations When Conducting an Interview........................................................... 3.303 Elements of Conversations......................................................................................................... 3.305 Inhibitors of Communication.................................................................................................... 3.306 viii Fraud Examiners Manual: 2022 Edition MENU FRAUD EXAMINERS MANUAL INVESTIGATION INTERVIEW THEORY AND APPLICATION (CONT.) Facilitators of Communication.................................................................................................. 3.309 Interviewing Methods and Techniques..................................................................................... 3.311 Interview Mechanics.................................................................................................................... 3.321 Question Typology...................................................................................................................... 3.325 Introductory Questions............................................................................................................... 3.327 Informational Questions............................................................................................................. 3.335 Closing Questions........................................................................................................................ 3.349 Assessment Questions................................................................................................................. 3.352 INTERVIEWING SUSPECTS AND SIGNED STATEMENTS Admission-Seeking Questions.................................................................................................... 3.401 Signed Statements........................................................................................................................ 3.426 Criteria-Based Statement Analysis............................................................................................. 3.429 COVERT OPERATIONS Establishing an Identity............................................................................................................... 3.502 Objectives...................................................................................................................................... 3.503 Problems in Covert Operations................................................................................................. 3.504 Surveillance................................................................................................................................... 3.506 Sources and Informants.............................................................................................................. 3.514 Use of Operatives........................................................................................................................ 3.522 SOURCES OF INFORMATION Public Versus Nonpublic Records............................................................................................. 3.602 Laws Governing Access to Information.................................................................................. 3.605 Local Records............................................................................................................................... 3.607 Court Records............................................................................................................................... 3.609 Property Records.......................................................................................................................... 3.614 Business (Corporate) Filings....................................................................................................... 3.617 Other Agency Records................................................................................................................ 3.619 Nonpublic Records...................................................................................................................... 3.624 Other Non-Government Sources.............................................................................................. 3.631 Accessing Information Online................................................................................................... 3.633 Additional Information Sources................................................................................................ 3.666 DATA ANALYSIS AND REPORTING TOOLS Understanding the Need for Data Analysis............................................................................. 3.701 Data Mining.................................................................................................................................. 3.703 Fraud Examiners Manual: 2022 Edition ix MENU FRAUD EXAMINERS MANUAL INVESTIGATION DATA ANALYSIS AND REPORTING TOOLS (CONT.) The Data Analysis Process......................................................................................................... 3.705 Spectrum of Analysis................................................................................................................... 3.712 Using Data Analysis Software.................................................................................................... 3.713 Textual Analytics.......................................................................................................................... 3.739 Visual Analytics............................................................................................................................ 3.742 Evaluating Data Analysis Software............................................................................................ 3.746 Reporting and Case Management Software............................................................................. 3.749 DIGITAL FORENSICS Conducting an Investigation Involving Computers................................................................ 3.801 Investigations and Digital Forensics......................................................................................... 3.814 Investigating in the Cloud........................................................................................................... 3.830 Mobile Forensic Investigations.................................................................................................. 3.834 Digital Forensics Software.......................................................................................................... 3.840 TRACING ILLICIT TRANSACTIONS General Process for Tracing Illicit Transactions..................................................................... 3.901 Direct Methods of Tracing Financial Transactions................................................................ 3.911 Indirect Methods of Tracing Financial Transactions.............................................................. 3.941 Locating Hidden Assets.............................................................................................................. 3.958 Asset Recovery............................................................................................................................. 3.978 REPORT WRITING Types of Reports.......................................................................................................................... 3.1001 Preparation.................................................................................................................................... 3.1002 Characteristics of a Good Report.............................................................................................. 3.1003 Common Reporting Mistakes.................................................................................................... 3.1005 Organization of Information...................................................................................................... 3.1009 Analyzing the Reader................................................................................................................... 3.1010 Outlining........................................................................................................................................ 3.1013 Grammatical Considerations...................................................................................................... 3.1014 Report Structure........................................................................................................................... 3.1018 Reporting Documents................................................................................................................. 3.1027 Visual Aids.................................................................................................................................... 3.1031 Presenting the Case for Prosecution......................................................................................... 3.1036 x Fraud Examiners Manual: 2022 Edition MENU FRAUD EXAMINERS MANUAL INVESTIGATION APPENDIX A: ENGAGEMENT AND ADVISORY LETTERS Fraud Examination Engagement Letters.................................................................................. 3.1101 Fraud Examination Advisory Letters........................................................................................ 3.1103 APPENDIX B: FRAUD EXAMINATION CHECKLIST Fraud Examination Checklist..................................................................................................... 3.1201 APPENDIX C: SAMPLE FORMS Consent to Search........................................................................................................................ 3.1301 Telephone Recording Consent................................................................................................... 3.1303 Consent to Record....................................................................................................................... 3.1304 Customer Consent and Authorization for Access to Financial Records............................. 3.1305 Fraud Incident Report Log......................................................................................................... 3.1306 Inventory of Evidence and Chain of Custody Log................................................................. 3.1308 Evidence Control Log................................................................................................................. 3.1309 APPENDIX D: SAMPLE FRAUD EXAMINATION REPORTS Short-Form Report...................................................................................................................... 3.1402 Long-Form Report...................................................................................................................... 3.1409 APPENDIX E: SAMPLE EXPERT WITNESS REPORT Expert Witness Report................................................................................................................ 3.1501 Fraud Examiners Manual: 2022 Edition xi MENU FRAUD EXAMINERS MANUAL SECTION 4 FRAUD PREVENTION AND DETERRENCE UNDERSTANDING CRIMINAL BEHAVIOR Behavioral Analysis and the Prevention of Fraud................................................................... 4.101 Why People Obey the Law......................................................................................................... 4.107 Theories of Crime Causation..................................................................................................... 4.116 WHITE-COLLAR CRIME What Is White-Collar Crime?..................................................................................................... 4.201 Crimes of the Middle Classes⎯A Look at White-Collar Crime.................................................. 4.202 Referring White-Collar Criminals to Law Enforcement........................................................ 4.212 Organizational Crime.................................................................................................................. 4.214 Occupational Fraud..................................................................................................................... 4.230 Research in Occupational Fraud and Abuse............................................................................ 4.231 CORPORATE GOVERNANCE Who Is Involved in Corporate Governance?........................................................................... 4.301 The Role of Corporate Governance in Fighting Fraud.......................................................... 4.307 Principles of Corporate Governance........................................................................................ 4.308 Establishing a Corporate Governance Framework................................................................. 4.321 Sources of Corporate Governance Guidance.......................................................................... 4.322 MANAGEMENT’S FRAUD-RELATED RESPONSIBILITIES The Legal Foundation for Management’s Fraud-Related Responsibilities.......................... 4.401 Management’s Responsibility for Internal Controls............................................................... 4.402 Management’s Responsibility for an Effective Compliance and Ethics Program.............. 4.406 Document Retention Policies.................................................................................................... 4.416 AUDITORS’ FRAUD-RELATED RESPONSIBILITIES External Auditors’ Fraud-Related Responsibilities................................................................. 4.501 Internal Auditors’ Fraud-Related Responsibilities.................................................................. 4.525 Government Auditors’ Fraud-Related Responsibilities.......................................................... 4.533 FRAUD PREVENTION PROGRAMS Selling Fraud Prevention to Management................................................................................ 4.601 Procedures to Prevent Fraud...................................................................................................... 4.602 Anti-Fraud Policy......................................................................................................................... 4.617 xii Fraud Examiners Manual: 2022 Edition MENU FRAUD EXAMINERS MANUAL FRAUD PREVENTION AND DETERRENCE FRAUD PREVENTION PROGRAMS (CONT.) Ethics Programs........................................................................................................................... 4.621 Sample Anti-Fraud Policy........................................................................................................... 4.625 Fraud Policy Decision Matrix..................................................................................................... 4.629 Sample Code of Business Ethics and Conduct........................................................................ 4.630 FRAUD RISK ASSESSMENT What Is Fraud Risk?.................................................................................................................... 4.701 What Factors Influence Fraud Risk?......................................................................................... 4.701 What Is a Fraud Risk Assessment?............................................................................................ 4.703 Preparing the Company for a Fraud Risk Assessment........................................................... 4.710 Fraud Risk Assessment Frameworks........................................................................................ 4.714 Addressing the Identified Fraud Risks...................................................................................... 4.731 Responding to Residual Fraud Risks......................................................................................... 4.733 Reporting the Results of the Fraud Risk Assessment............................................................. 4.735 Making an Impact with the Fraud Risk Assessment............................................................... 4.737 The Fraud Risk Assessment and the Audit Process............................................................... 4.738 Fraud Risk Assessment Tools and Resources.......................................................................... 4.739 FRAUD RISK MANAGEMENT Foundational Guidance for Fraud Risk Management............................................................ 4.801 What Is Risk Management?........................................................................................................ 4.801 Risk Management Frameworks.................................................................................................. 4.803 Integrating Anti-Fraud Initiatives into Risk Management..................................................... 4.807 Managing Third-Party Fraud Risks............................................................................................ 4.809 Who Is Responsible for Managing Fraud Risk?...................................................................... 4.814 The Objectives of a Fraud Risk Management Program......................................................... 4.819 Fraud Risk Management Principles........................................................................................... 4.819 Steps in Developing a Fraud Risk Management Program..................................................... 4.824 Fraud Risk Management Program Components..................................................................... 4.828 The Use of Data Analytics in Managing Fraud Risk.............................................................. 4.832 ETHICS FOR FRAUD EXAMINERS What Is Ethics?............................................................................................................................ 4.901 Morality, Ethics, and Legality..................................................................................................... 4.903 Conclusion.................................................................................................................................... 4.907 Fraud Examiners Manual: 2022 Edition xiii MENU FRAUD EXAMINERS MANUAL FRAUD PREVENTION AND DETERRENCE ACFE CODE OF PROFESSIONAL ETHICS Commitment to Professionalism and Diligence...................................................................... 4.1002 Legal and Ethical Conduct and Conflict of Interest............................................................... 4.1005 Integrity and Competence........................................................................................................... 4.1009 Court Orders and Testimony..................................................................................................... 4.1012 Reasonable Evidential Basis for Opinions............................................................................... 4.1013 Confidential Information............................................................................................................ 4.1016 Complete Reporting of Material Matters.................................................................................. 4.1022 Professional Improvement......................................................................................................... 4.1023 CFE CODE OF PROFESSIONAL STANDARDS CFE Code of Professional Standards....................................................................................... 4.1101 xiv Fraud Examiners Manual: 2022 Edition MENU PREFACE The Fraud Examiners Manual, published by the Association of Certified Fraud Examiners (ACFE), contains the primary body of knowledge on which the Certified Fraud Examiner (CFE) credential is based, and it continues to function as an essential reference tool for anti- fraud professionals long after the certification has been obtained. The Fraud Examiners Manual’s content is organized into four main sections: Financial Transactions and Fraud Schemes, Law, Investigation, and Fraud Prevention and Deterrence. The Financial Transactions and Fraud Schemes section describes thousands of fraud schemes and the techniques that can be used to prevent and detect them. This section begins with an overview of basic accounting concepts. It then discusses various occupational fraud schemes (i.e., asset misappropriations, corruption, and fraudulent financial statements), organized in a taxonomy originally developed for the book Occupational Fraud and Abuse (now The Corporate Fraud Handbook). The remainder of this section details a number of other fraud schemes ranging from financial institution fraud to health care fraud. The Law section focuses on the statutes and common law principles involved in prosecuting fraudsters through both the criminal and civil systems; the legal nuances involved in examining several specific categories of fraud, such as money laundering and securities fraud; and the legal challenges one might encounter in conducting an investigation. It also contains information about how to testify as a witness. The Investigation section provides the basic tools and techniques necessary to develop information and evidence when conducting a fraud examination and identifying the perpetrators. It describes how to gather testimonial, digital, and documentary evidence and provides guidance regarding interview best practices. It also contains information about using data analysis techniques, digital forensics, public records, and the internet to locate evidence and other resources. The Fraud Prevention and Deterrence section reflects a concrete approach to preventing and deterring fraud. It not only discusses why people commit crime, but it also contains practicable advice about how to use that knowledge to prevent fraud through proactive policies, formal fraud risk assessment and fraud risk management initiatives, corporate governance practices, and compliance programs. It also includes a number of meaningful Fraud Examiners Manual: 2022 Edition P-1 MENU PREFACE statistics about fraud, as well as a discussion of the types and impact of organizational and occupational crime. This section concludes with a discussion of the ACFE Code of Professional Ethics and its meaning for fraud examiners. The content presented in the Fraud Examiners Manual is intended to apply to a global audience. It is up to the individual user to seek out additional information or professional advice based on the rules in their particular jurisdiction; however, some additional country- specific supplemental information can be found in the online version of the Manual located at fraudexaminersmanual.com. If you have questions or feedback regarding the content of the Fraud Examiners Manual, please contact us at [email protected]. Thanks and Acknowledgements We would like to acknowledge the assistance of the following experts in contributing material to this publication: Derek Baldwin, Lesley Baldwin, Paul Barnes, Bob Bauman, Neil Bebbington, Charlotte J. Bell, Thomas Bell, Chelsea Binns, Tasha Bollinger, Dick Brodfuehrer, Chris Campos, Larry Cook, Dave Cotton, Tom Creelman, Don Dame, Bruce Dean, Joe Dervaes, Chris Dorman, Stuart Douglas, Ron Durkin, Dennis Dycus, David Elzinga, Bryan Farrell, John Francolla, Paul French, Sunder Gee, Mason Haynesworth, Jim Healy, Steve Hendrix, Dick Hollinger, Frank Howatt, James Incaprera, Bethmara Kessler, Mike Kline, Joyce C. Lambert, Mike Lawrence, Frank Leggio, Jim Lile, Bob Lindquist, Kathleen Lower, Tony Maceo, Judge Frank Maloney, Walt Manning, John McLaren, Bob Miller, Frank Nasuti, Dick Nossen, Joan Norvelle, Brett Holloway-Reeves, Ric Rowe, William N. Rudman, Mike Ryman, Ken Sibley, Craig Starr, Bill Thornhill, Don Wall, and John Fisher Weber. Final thanks go to the ACFE staff. We are especially appreciative of the efforts of Ron Cresswell, Christian Gamboa, Laura Harris, Jay Harward, Yasmin Hoffmann, Laura Hymes, Jeanette LeVie, Jennifer Liebman, Andi McNeal, Eryn Moris, Jacob Parks, Kate Pospisil, Amy Scott, John Warren, and Mason Wilder. Authors: Joseph T. Wells, CFE, CPA Nancy S. Bradford, CFE, CPA, CIA Gilbert Geis, Ph.D. P-2 Fraud Examiners Manual: 2022 Edition MENU PREFACE John D. Gill, J.D., CFE W. Michael Kramer, J.D., CFE James D. Ratley, CFE Jack Robertson, Ph.D., CFE, CPA Austin, Texas October 2021 Fraud Examiners Manual: 2022 Edition P-3 MENU FINANCIAL TRANSACTIONS AND FRAUD SCHEMES TABLE OF CONTENTS ACCOUNTING CONCEPTS Accounting Basics........................................................................................................................ 1.101 Accounts and the Accounting Cycle.................................................................................. 1.102 Journal Entries....................................................................................................................... 1.103 Accounting Methods............................................................................................................ 1.104 Cash-Basis Accounting.................................................................................................. 1.104 Accrual-Basis Accounting............................................................................................. 1.105 Financial Statements.................................................................................................................... 1.105 Balance Sheet......................................................................................................................... 1.107 Income Statement................................................................................................................. 1.109 Statement of Changes in Owners’ Equity.......................................................................... 1.112 Statement of Cash Flows..................................................................................................... 1.113 Cash Flows from Operations....................................................................................... 1.114 Cash Flows from Investing Activities......................................................................... 1.115 Cash Flows from Financing Activities........................................................................ 1.116 Users of Financial Statements............................................................................................. 1.116 Generally Accepted Accounting Principles.............................................................................. 1.116 International Financial Reporting Standards..................................................................... 1.117 Qualitative Characteristics of Useful Financial Information................................... 1.117 Recognition of the Elements of Financial Statements.............................................. 1.120 Measurement of the Elements of Financial Statements........................................... 1.123 Departures from Generally Accepted Accounting Principles........................................ 1.123 Conservatism................................................................................................................... 1.124 Industry Practices and Peculiarities.............................................................................. 1.125 Substance over Form..................................................................................................... 1.125 Application of Judgment............................................................................................... 1.125 Materiality........................................................................................................................ 1.125 Cost-Benefit.................................................................................................................... 1.125 FINANCIAL STATEMENT FRAUD What Is Financial Statement Fraud?......................................................................................... 1.203 The Cost of Financial Statement Fraud.................................................................................... 1.204 Why Financial Statement Fraud Is Committed....................................................................... 1.204 Trends in Financial Statement Fraud........................................................................................ 1.206 Financial Statement Fraud Schemes.......................................................................................... 1.208 Fictitious Revenues............................................................................................................... 1.211 What Red Flags Are Associated with Fictitious Revenues?..................................... 1.215 Timing Differences (Including Improper Revenue Recognition).................................. 1.215 Premature Revenue Recognition.................................................................................. 1.215 Sales with Conditions..................................................................................................... 1.218 Fraud Examiners Manual: 2022 Edition 1.i MENU FINANCIAL TRANSACTIONS AND FRAUD SCHEMES FINANCIAL STATEMENT FRAUD (CONT.) Long-Term Contracts.................................................................................................... 1.219 Multiple Deliverables..................................................................................................... 1.219 Channel Stuffing............................................................................................................. 1.219 Recording Expenses in the Wrong Period................................................................. 1.220 What Red Flags Are Associated with Timing Differences (Including Improper Revenue Recognition)?............................................................................. 1.220 Improper Asset Valuation.................................................................................................... 1.221 Inventory Valuation....................................................................................................... 1.222 Accounts Receivable...................................................................................................... 1.222 Business Combinations.................................................................................................. 1.224 Fixed Assets..................................................................................................................... 1.224 Understating Assets........................................................................................................ 1.226 Misclassifying Assets...................................................................................................... 1.226 What Red Flags Are Associated with Improper Asset Valuation?.......................... 1.226 Concealed Liabilities and Expenses.................................................................................... 1.226 Liability/Expense Omissions....................................................................................... 1.227 Improperly Capitalized Costs....................................................................................... 1.229 Unrecorded and Undisclosed Warranty Costs and Product-Return Liabilities....................................................................................................................... 1.231 What Red Flags Are Associated with Concealed Liabilities and Expenses?..................................................................................................................... 1.232 Improper Disclosures........................................................................................................... 1.232 Contingent Liabilities..................................................................................................... 1.233 Subsequent Events......................................................................................................... 1.233 Management Fraud........................................................................................................ 1.233 Related-Party Transactions........................................................................................... 1.233 Accounting Changes...................................................................................................... 1.235 Backdating Stock Options............................................................................................. 1.235 What Red Flags Are Associated with Improper Disclosures?................................. 1.236 What Red Flags Are Associated with Financial Statement Fraud in General?................... 1.237 Detection of Fraudulent Financial Statement Schemes......................................................... 1.238 Financial Statement Analysis...................................................................................................... 1.240 Vertical Analysis.................................................................................................................... 1.241 Horizontal Analysis............................................................................................................... 1.241 Ratio Analysis......................................................................................................................... 1.243 Common Financial Ratios............................................................................................. 1.244 Tax Return Review................................................................................................................ 1.247 Interviews in Fraudulent Financial Statement Cases.............................................................. 1.248 Interviewing Techniques...................................................................................................... 1.248 The Interview.................................................................................................................. 1.250 Prevention of Financial Statement Fraud................................................................................. 1.256 Management and the Board of Directors.......................................................................... 1.256 1.ii Fraud Examiners Manual: 2022 Edition MENU FINANCIAL TRANSACTIONS AND FRAUD SCHEMES FINANCIAL STATEMENT FRAUD (CONT.) Reduce the Situational Pressures That Encourage Financial Statement Fraud............................................................................................................................. 1.256 Reduce the Opportunity to Commit Fraud................................................................ 1.257 Reduce the Rationalization of Fraud—Strengthen Employee Personal Integrity........................................................................................................................ 1.257 Internal Auditors................................................................................................................... 1.257 External Auditors.................................................................................................................. 1.258 ASSET MISAPPROPRIATION: CASH RECEIPTS Skimming....................................................................................................................................... 1.301 Sales Skimming...................................................................................................................... 1.302 Register Manipulation.................................................................................................... 1.304 Skimming During Nonbusiness Hours....................................................................... 1.305 Skimming of Off-Site Sales........................................................................................... 1.305 Poor Collection Procedures.......................................................................................... 1.306 Understated Sales........................................................................................................... 1.307 Theft of Checks Received Through the Mail............................................................. 1.309 Check for Currency Substitutions....................................................................................... 1.311 Skimming Receivables.......................................................................................................... 1.312 Forcing Account Balances or Destroying Transaction Records............................. 1.312 Lapping............................................................................................................................ 1.313 Stolen Statements........................................................................................................... 1.314 False Accounting Entries.............................................................................................. 1.315 Inventory Padding................................................................................................................. 1.316 Short-Term Skimming.......................................................................................................... 1.317 Detection of Skimming Schemes........................................................................................ 1.317 Receipt- or Sales-Level Detection................................................................................ 1.317 Journal Entry Review..................................................................................................... 1.317 Detecting Lapping of Sales or Receivables................................................................. 1.318 Prevention of Skimming Schemes...................................................................................... 1.318 Receipt- or Sales-Level Control.................................................................................... 1.318 General Controls............................................................................................................ 1.319 Skimming Controls......................................................................................................... 1.319 Cash Larceny................................................................................................................................. 1.320 Incoming Cash....................................................................................................................... 1.321 Theft of Cash from the Register.................................................................................. 1.321 Other Larceny of Sales and Receivables..................................................................... 1.324 Cash Larceny from the Deposit.......................................................................................... 1.325 Deposit Lapping............................................................................................................. 1.328 Deposits in Transit......................................................................................................... 1.329 Detection of Cash Larceny.................................................................................................. 1.329 Fraud Examiners Manual: 2022 Edition 1.iii MENU FINANCIAL TRANSACTIONS AND FRAUD SCHEMES ASSET MISAPPROPRIATION: CASH RECEIPTS (CONT.) Receipt Recording.......................................................................................................... 1.329 Control Objectives......................................................................................................... 1.329 Analytical Review........................................................................................................... 1.330 Detection at the Register............................................................................................... 1.331 Cash Account Analysis.................................................................................................. 1.331 Prevention of Cash Larceny................................................................................................ 1.331 Separation of Duties...................................................................................................... 1.332 Assignment Rotation and Mandatory Vacations....................................................... 1.332 Surprise Cash Counts and Procedure Supervision.................................................... 1.332 Physical Security of Cash............................................................................................... 1.333 Theft of Cash on Hand............................................................................................................... 1.333 ASSET MISAPPROPRIATION: FRAUDULENT DISBURSEMENTS Register Disbursement Schemes................................................................................................ 1.401 False Refunds......................................................................................................................... 1.401 Fictitious Refunds........................................................................................................... 1.403 Overstated Refunds........................................................................................................ 1.403 Payment Card Refunds.................................................................................................. 1.403 False Voids............................................................................................................................. 1.404 Concealing Register Disbursement Schemes.................................................................... 1.407 Small Disbursements...................................................................................................... 1.407 Destroying Records........................................................................................................ 1.408 Detection of Register Disbursement Schemes................................................................. 1.408 Fictitious Refunds or Voided Sales.............................................................................. 1.408 Review and Analysis of Decreases in Gross Sales or Increases in Returns and Allowances................................................................................................................... 1.408 Register Disbursement Scheme Red Flags................................................................. 1.409 Prevention of Register Disbursement Schemes................................................................ 1.409 Payment Tampering Schemes.................................................................................................... 1.410 Check Tampering Schemes.................................................................................................. 1.410 Forged Maker Schemes................................................................................................. 1.411 Forged Endorsement Schemes..................................................................................... 1.417 Altered Payee Schemes.................................................................................................. 1.421 Authorized Maker Schemes.......................................................................................... 1.424 Concealing Check Tampering Schemes...................................................................... 1.427 Detection of Check Tampering Schemes................................................................... 1.431 Prevention of Check Tampering Schemes................................................................. 1.432 Electronic Payment Tampering........................................................................................... 1.434 Prevention and Detection of Electronic Payment Tampering................................ 1.435 Billing Schemes............................................................................................................................. 1.437 Invoicing Via Shell Companies........................................................................................... 1.437 1.iv Fraud Examiners Manual: 2022 Edition MENU FINANCIAL TRANSACTIONS AND FRAUD SCHEMES ASSET MISAPPROPRIATION: FRAUDULENT DISBURSEMENTS (CONT.) Forming a Shell Company............................................................................................. 1.437 Submitting False Invoices............................................................................................. 1.440 Self-Approval of Fraudulent Invoices......................................................................... 1.440 Negligent Supervisors.................................................................................................... 1.441 Reliance on False Documents...................................................................................... 1.441 Collusion.......................................................................................................................... 1.441 Purchases of Services Rather than Goods.................................................................. 1.442 Pass-Through Schemes.................................................................................................. 1.442 Invoicing Via Nonaccomplice Vendors............................................................................. 1.443 Pay and Return Schemes............................................................................................... 1.443 Overbilling with a Nonaccomplice Vendor’s Invoices............................................. 1.445 Personal Purchases with Company Funds......................................................................... 1.445 Personal Purchases Through False Invoicing............................................................ 1.445 Personal Purchases on Credit Cards or Other Company Accounts....................... 1.449 Returning Merchandise for Cash........................................................................................ 1.451 Detection of Billing Schemes.............................................................................................. 1.451 Analytical Review........................................................................................................... 1.452 Data Analytics................................................................................................................. 1.452 Statistical Sampling......................................................................................................... 1.453 Vendor or Outsider Complaints.................................................................................. 1.453 Site Visits—Observation............................................................................................... 1.453 Sample Audit Program.................................................................................................. 1.453 Prevention of Billing Schemes............................................................................................ 1.455 Education (Training)...................................................................................................... 1.455 Compensation.............................

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