Frauds — A compilation

Consider the following situation :

During the audit of a bank branch (which is a semi-urban branch and has been put under concurrent audit for the first time), the concurrent auditors found that the total working is in a mess. Loan applications for loans already disbursed are not on record, disbursement conditions are not complied with, hypothecation agreements are incomplete, mortgages wherever necessary are pending and number of lacunae are observed in the processing of proposals, which are under the Branch Manager’s powers.

On questioning, the Branch Manager started giving number of excuses and explanations like — "I cannot concentrate as my wife is sick", "The staff is useless and do not co-operate", "There is too much pressure from higher authorities for achieving targets", "The customers have become too demanding and expect the Branch Manager to prepare the loan applications for them" . . . etc., etc.

The overall advances portfolio did not appear to reflect quality assets and therefore, the concurrent auditors reported everything to the Banks’ Controlling Authorities. They also submitted a Special Observation Report on various aspects of branch working.

The irregularities persisted for quite some time and, therefore, the auditors requested the Controlling Authorities to monitor the branch closely, considering the various risk factors that are surfacing. The Controlling Authorities then sent their own internal audit team for assessment of branch working. When the observations of concurrent auditors are confirmed by the internal inspectors, they put the Branch Manager under suspension and another Senior Manager replaces him at the branch.

After the suspension of Branch Manager, the junior staff started speaking. They informed the auditors that the Branch Manager was running the branch after the working hours, when he would personally attend to the prospective borrowers. No other staff member was taken into his confidence and most of the advances under his powers were processed, finalised and disbursed by himself. It appeared quite obvious that he was getting some consideration for the extra favour shown to the borrowers.

This is a typical situation conducive to fraud. It can also be called as red flag (warning signals), which needs to be understood to unearth or prevent frauds.

Had the auditors relied on the innocence displayed by the Branch Manager or his request not to cover various irregularities in their Report been acceded to, it would have probably resulted into discovery of a significant fraud later on.

Fraud is a type of illegal act in which the perpetrator obtains something of value through wilful representation. Fraud usually occurs within the context of legitimate business transactions and is carried out in such a manner that legitimate business unwittingly conceals it.

The Public Oversight Board of USA, in a special report ‘In the Public Interest’ concluded that :

"The public looks to the independent auditors to detect frauds and it is the auditors’ responsibility to do so."

In this regard, the AICPA adopted Statement on Auditing Standards 82, ‘Considerations of Fraud in a Financial Statement Audit’, which confirms the profession’s commitment to detecting frauds.

The Institute of Chartered Accountants of India, not to be left behind, issued Auditing & Assurance Standard 4 — "The Auditors’ Responsibility to Consider Fraud & Error in an Audit of Financial Statements." The basic tenet of which is as follows:

The responsibility for prevention and detection of frauds and errors is of the management. Auditor has to obtain reasonable assurance that financial information is properly stated in all material aspects. Therefore, he has to seek reasonable assurance that frauds and errors, which may be material, have not occurred or if occurred, the effect of the fraud is properly reflected or that of an error is corrected. Therefore, he must plan his audit in such a way that he has reasonable expectation of detecting material misstatement resulting from frauds and errors.

It is not that the Chartered Accountants/CPAs did not detect frauds earlier. In fact, there are countless instances when they have detected financial frauds and embezzlements. However, the fact is that they are not trained formally in detecting frauds. And now, since the dimensions of frauds have taken mammoth proportions, it has become imperative for them to get more acquainted with this subject.

Fraud is a trickery that falls into two basic categories :

1. Internal frauds, which are committed by employees and officers of the organisations.

2. External frauds, which are committed by an organisation against an individual, by an individual against an organisation, by an organisation against another organisation and by an individual against another individual.

Although both types of frauds are of concern, normally internal frauds, which are also described as occupational frauds and abuse are found to be more common. The scope of such frauds is so broad that it includes asset misappropriation, corruption, pilferage and petty theft, false overtime, fraudulent financial statements, using company property for personal benefit, payroll and seek time abuses, etc.

The Association of Certified Fraud Examiners, after a 1996 survey of 1523 cases of frauds, has compiled the following facts about occupational frauds :

• Small businesses experience fraud losses at a rate of nearly 100 times that of the larger ones.

• Occupational frauds fall into three categories : asset misappropriation, corruption and fraudulent financial statements.

• Asset misappropriations account for more than 80% of cases, but they are the least expensive of the three fraud categories.

• Fraudulent financial statements, which account for less than 4% of fraud litigation, are the most costly occupational frauds.

• Real estate financing has the highest fraud losses; education the lowest.

• A direct link exists between the age, sex, education, and position of the perpetrator and the amount lost. The highest median losses occur with older male executives who are senior officials of their organisations. The smallest losses are with high-school graduates, who have been in a company for less than a year.

• Frauds and white-collar crimes are typically committed by older, better educated offenders. On top of that, the use of computers and technology to aid in the commission of crimes has become widespread.

How frauds are committed — Some examples :

Numerous methods of committing frauds have surfaced with the advent of credit cards, ATMs and the Internet. Internet frauds are not only very difficult to detect, but are difficult to combat also. Identity theft is one such fraud, where a criminal uses your name and credit card number/ATM card number to assume your identity and creates unmanageable debt for you. How is the identity stolen ? The person gets access to the personal information from old bank statements, copies of bills, credit card statements, etc. by digging through mailbox or stealing from purse. After having obtained the information, assuming your identity becomes easy with the help of sophisticated tools such as computers, scanners, etc.

Nowadays, hackers take control of the personal computer of a person by using sophisticated Internal tools and software. The login information, credit card numbers, credit limits, passwords, PIN, etc. related to that person are obtained unknowingly when that person is surfing the web and later on, used for pecuniary gains. In one such fraud reported earlier, an 18-year old European boy had stolen the credit card numbers and PIN of none other than the Microsoft Chief — Bill Gates and defrauded him by making huge purchases on those credit cards.

In the last few years, frauds have come to light in a number of financial statements, which have compelled the governments and the accounting bodies all over the world to introduce number of stringent measures to protect the interest of innocent investors and other stake-holders in the companies. Notable among such frauds being Enron, Parmalat, WorldCom., etc. in which by making financial misrepresentation, the managements defrauded the investors and other stake-holders billions of dollars and those corporations which were till recently great corporations having worldwide operations, had to be wound up as they could not repay the public debt. In India, too, we are witness to a number of such frauds, the notable being MS Shoes, Madhavpura Bank, etc. We are also witness to a large number of vanishing companies, which lured investors to invest in their plantation schemes which were on paper only. All those companies vanished after collecting huge sums of money from the investors.

1. Showing enhanced revenues and sales by fictitious accounting entries.

2. Showing enhanced assets valuation to obtain large loans from banking system.

3. Showing high profits by concealing liabilities and provisions for expenses.

4. Falsifying accounts by abruptly changing method of accounting and not disclosing effect of such change in the financial statements.

5. Claiming false deductions in accounts to defraud the exchequer of the taxes due to the Government.

6. Taking advantage of cut-off dates to shift incomes/expenses to other periods to show a picture different than what it is actually.

We come across instances when a person, for securing a job, poses to be a graduate while actually he does not possess any degree. There are other instances of such frauds, such as — manipulation of mark-sheets, copying during the exams, manipulation of records or obtaining false caste certificate for securing admission in college, for securing lucrative government jobs under reserve category, etc.

In a recent incident, a student from Ballia in Uttar Pradesh claimed to have topped a NASA Examination. He could convince the Media and the Authorities of the genuineness of his claim. On the basis of that, the President of India and also the Prime Minister had granted meetings with him. The news was flashed across the Globe through newspapers and the TV channels. However, a chance enquiry by an American news-reporter with NASA revealed that no such exam was held and the boy, claiming to have topped the said exam, was never even heard of. That is how the fraud was exposed.

To protect an organisation from internal frauds, it is necessary to introduce appropriate internal control measures such as segregation of duties, maker-checker system, sampling procedures, surprise checks, rotation of jobs, etc. To protect against computer frauds, the organisation needs to introduce appropriate control procedures such as input-output controls, physical and logical access controls, communication controls, data encryption, etc.

Individuals can protect themselves from various financial frauds by taking following precautions :

1. ATM : Ensure that you are not being watched by anybody while inputting the PIN. Also ensure that no hidden camera has been fixed somewhere there.

2. Do not use your PCO for making transactions through tele-banking services.

3. Do not give your credit card number to anybody who calls on you and asks for the number by pretending to be calling from your bank or credit card agency.

4. Change your PIN or password at periodic intervals. But ensure not to keep the changed password/PIN in written form in purse, etc.

5. Do not use names of your close relatives or date of birth/date of wedding anniversary as password, as they can be easily guessed.

6. Keep your mailbox locked to ensure that nobody has easy access to the bank statements/credit card state-ments received in a mailbox.

7. Keep away from ‘too good to be true’ offers received in the mailbox or those you may come across over the Internet. Also keep away from various lucrative offers you may receive through tele-marketing services.

8. Be wary of schemes, which offer good prizes in exchange for purchasing a product or investing in a scheme.

9. When any natural calamity hits, number of charitable organisations spring up like mushroom to collect money for helping the victims. While donating, be very careful and check the antecedents of such organisations, as many of them would be fake.

10. Keep away from investment ideas and schemes, which offer hefty returns, which are too lucrative under normal circumstances.

11. Number of advertisements appear in newspapers offering excellent returns in exchange for working at home or working under a franchise. They offer lots of money for too little work. Many a person who accepts the offer finds himself being duped in the end.

12. Number of multilevel marketing schemes are in operation through the year. Marketing of such schemes is done very innovatively and very aggressively. Very few people really get benefited in such schemes and most of the participants ultimately lose money. Therefore keep away from such schemes.

13. After the advent of the BPO boom, number of smart cronies have started duping gullible youngsters with the offer of work, which may fetch excellent returns. What they are asked to do is to convert JPEJ files into word files and some such work. The person interested is asked to deposit certain sum of money upfront, to cover the losses the company may incur if the work is not completed in time. Initially for a few months, payment against the work submitted is made very promptly. Everything is done so smartly that nobody would even suspect anything wrong. As the word spreads, more and more people get attracted towards the work, since the nature of work is very simple while the returns are excellent. When large number of vendors are appointed and deposits collected, suddenly the company disappears putting every-body to huge losses. Recently, a large number of people in Pune and Mumbai lost crores of rupees in one such fraud.

As per a study done by INTOSAI, USA, the potential for committing fraud is greater when one or more of the following elements exist :

(a) Perceived need — The motivation for most frauds is financial by nature and is fuelled by perceived needs or desires of the individuals committing frauds.

(b) Opportunity — The opportunity to commit fraud must exist and a weak internal control provides such an environment.

(c) Rationalisation — Individuals responsible for frauds always rationalise their action e.g., "They owe me", "The organisation is so big that if I take away something, it will never be missed", etc.

To detect frauds, one needs to understand the signs, signals and patterns, which point towards the fraudulent situation.

As the world economy grows with the help of e-commerce, the quantum of losses incurred due to frauds would go up substantially, so also the demand for experts, who have the requisite knowledge and experience to detect frauds. Therein lies a great opportunity for Chartered Accountants.

Article by Gokul B. Rathi, Chartered Accountant