Study of Frauds and Assets Misappropriations A Forensic Way

Research by: Yash D. Thakkar

Membership No: MRA/CPA(Australia) 00001

Abstract

This study makes an attempt to fraud and its various kinds. It explains reasons behind frauds and
suggests techniques at micro and macro level of universe to understand frauds. One of the most
significant numbers of frauds are via assets misappropriation. This paper attempts to study effect of
assets misappropriation, identification and suggests simpleprevention methodsto reduce assets
misappropriation. This paper enables readers to understand how asset misappropriation affects them as
individual, employees, citizen of nation and as an entrepreneur. How it affects wealth of nation, investors
and conglomerates. It further analysis various popular cases of frauds and real life cases studied by
author.

Introduction

The term fraud compromises any willful act deception which causes harm or gain to individual. Fraud has
been existence since introduction commerce in human race. Deception and camouflage are traits which
are god gifted to human beings and to great extend in animals, but human beings are only capable of
financial frauds. According to CPA Australia defines frauds “Fraud is behavior that is deceptive,
dishonest, corrupt or unethical. For fraud to exist there needs to be an offender, a victim and an absence of
control or safeguards.”

As per Duffield &Grabosky explains human physiology in fraud depends on three factors that is
motivation, opportunity and guardianship. Although there are various other reasons such situational or
entertainment or challenge are some other reason for frauds to take place, hence till date behavioral
scientists have been unable to identify a psychological characteristic that serves as a valid and reliable
marker of the propensity of an individual to commit fraud.

Organizations of all types and sizes are exposed to frauds. On a number of occasions over the past few
decades, major public companies have experienced in financial reporting fraud and corrupt practices,
resulting in turmoil in the capital markets, a loss of shareholder value, loss of goodwill, loss of assets, loss
of goods and eventually leading into closer of many supporting business to loss of employment.

Although there are various kinds of frauds according to Association of Certified Fraud Examiners
(ACFE) occupational frauds are classified into three categories which are corruption, fraudulent
statements and asset misappropriation.

Assets Misappropriation has received great attention from various stakeholders such regulatory body,
government, investors, public, media, corporates and financial committees. In India in past decade we
have come across various scandals and frauds on assets misappropriation, corruptions, fraudulent

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financial statements incases India such as 2G Scam, Coalgate, Shardha Scam, Kingfisher Airlines,
Satyam Computers, MCX Commodities, Harsad Mehta etc.

Across the globe we have come across frauds by Enron, World Com, HIH Insurance, Baring Corporation,
Leheman Brothers &Maddoff scandal.

Frauds have great deep impact on all business and its stakeholders. Frauds have cascading impacts on
regulators, rules, economic, business, markets and public at large. Across the globe new rules and laws
have been introduced when frauds are detected. People who commit frauds are driven by greedy and
supremacy and often forget to differentiate between their smartness, talent compared to deception.

Defining Assets Misappropriation

Asset misappropriation occurs when employee stealscompany’s cash or non-cash assets for the
employee’s own personal use. According to Majid (2010), the definition of asset misappropriation is
broader than simple theft as it also includes abuse of assets. When employee of any level from CEO to
daily hired contractor access company assets for personal or misuse company’s any kind of assets or
resources.Assets of the company include everything from office stationary, office furniture to expensive
items in inventory being used for non-company use. Use of company car, laptops, phones for personal use
or making company pay for services which are personal in nature.

Asset Misappropriation occurs in relative small and immaterial amounts which makes it difficult to detect
but is often accompanied by falsification of documents and behavior of perpetrators.Usually
Assetmisappropriationis moreconcealed anddifficult to detect when is involves management due to their
position or power. It is simple theft or minor misuse butoften perpetratorto conceal them leads them in to
greater financial fraud or fraudulent financial statements or corruption. (Soltani, 2007; Elder et al., 2010;
Jones, 2011)

According to CPA, Australia some of the most common examples of employee fraud include:

 Accepting gifts, favors, kickbacks and bribes from suppliers or contractors

 Staff providing services to the business at clients at cheap or lower rates
 Inflated/bogus reimbursement claims
 Manipulation of performance to receive performancebased bonuses
 Faking time sheets& attendance records
 Claiming false sick leaves
 Private personal expenses through business accounts/businesscredit cards
 Providing discounted or free goods or services to friendsand associates.

As per research undertaken by Association of Certified Fraud Examiners (ACFE), 2014 most common
among all the frauds is asset misappropriation which comprised of 85% of total frauds reported in year
2014 but which is least costly and where as 9% are frauds are of financial statements but has greatest
financial losses . The analysis of KPMG in 2013 has shown that 46% of economic crime is under asset
misappropriation schemes whereby corruption cases are reported at 31% and financial statement crimes at

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13%. AssetsMisappropriation has least median losses when compared with losses caused by
fraudulentfinancial statements and corruption.
As per ACFE Fraud Tree Asset misappropriation can be further classified into various categories such as
(1) Cash (2) Inventory & All other Assets.

ACFE has developed the Occupational Fraud and Abuse Classification System, also known as the Fraud
Tree.

Figure 1.1 from ACFE

According to the 2008 Report to the Nation on Occupational Fraud and Abuse, asset misappropriation
can be categorized according to different scheme types; skimming, cash larceny, fraudulent
disbursements, and non-cash larceny and misuse (ACFE, 2008).

Skimming refers to stealing of cash it includes those acts where funds are taken by the offender before the
funds have been recorded in the organization’s financial records. Skimming may occur at the point of
sale, cash counters, from receivables, or from refunds or from repayment of loans.

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Cash larceny refers to fraudulent acts that involve the theft of funds after they have been recorded. The
cash is stolen from the cash on hand, such as from the cash register or petty cash, or taken from a deposit.

Fraudulent disbursements cover a wide variety of schemes:

Billing schemes typically involve employers making payments based on false invoices for personal
purchases.

Check tampering refers to altering or forging an organization’s check for personal use.

Expense reimbursements include false claims of fictitious business expenses.

Payroll schemes resemble billing schemes in that payment is based on false documentation, such as
timecards, which indicated that compensation is fraudulently due to an employee.

Cash register disbursements entail false entries or “no sale” transactions to hide the removal of cash.

As per CPA Australia study a business is at a greatest risk of employee fraud when three conditions exists
motivation, opportunity, and rationalization.

When company makes the workplace a less pleasing because of economic constraints, employees are
faced with the motivation and rationalization needed to commit workplace theft. When employees are
aggrieved by management decision to promoted, discriminated employees are rationalizing themselves to
commit. Further when management is involved in exploiting various stakeholders who give the
opportunity to employees are more likely to commit fraud. “Tone of top of management “plays a pivotal
role for motivating and rationalization for committing fraud.

Asset Misappropriation in renowned Cases

In case of Enron asset misappropriation occurred when top executives were aware of actual financial
position and company shell position. 29 of Enron’s top executives and board members sold 20.7 million
of their Enron shares, for a gross proceed of $1.1 billion which works out to be $ 41 million in pay and
bonus among 29 executives.When company was made aware that two of its employees have over traders
and caused millions of dollars’ worth of loss to company and have also diverted funds into their own
account instead of disciplining them Chairman of the Company advise them to continue business as
normal. Further executives and management used company assets for personal fame. Amongst the most is
example was when Enron was about to collapse and CEO Jeff Skilling was under great stress of keeping
all the fraudulent activities away from public, company chairman Kenneth Lay was busy asking Jeff’s
help in selecting the fabric of interior of his corporate jet. Further executives were very well aware of
their fraudulent activities hence they tied up relationships with politician by giving generous donations
from company funds to protect their wrong doing and with intent to seeking support in judiciary matter.
According to McLean and Elkind (2003), “between 1989 and 2001 Enron and its executives contributed

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nearly $6 million to political parties and candidates. Further CFO of the company Andy Fastow had
interest in various SPE to which various transactions were entered by Enron skimming company cash.

Tyco arose a corporate scandal. In 2002, CEO Dennis Kozlowski, CFO Mark Swartz, and general counsel
Mark Belnick were 16 charged of fraud and conspiracy. Hundreds of millions of dollars that they had paid
themselves in unauthorized bonuses and compensation since 1992. In total, approximately $170 million
had been taken by the three. Although Tyco did have an employee loan program in place at the time,
these personal loans were never approved and were kept off the financial statements of the company.
Therefore, they were not considered an asset on the company’s balance sheet. Combined, Kozlowski and
Swartz had also sold $430 million worth of company stock without informing investors. Kozlowski,
especially, was known for his lavish lifestyle and habit of spending corporate funds. He reportedly held a
$2 million birthday party in Italy for his wife using company funds. There were also rumors of a $10,000
shower curtain he had purchased with company funds.

In case of Berni Madoff report byLauricella (2009), suggest that firms invested investor money to Madoff
Securities, “likely took in at least $790 million in fees over the years On its main Madoff channel, the
Fairfield Sentry fund, the firm for many years took as a management fee 20% of profits earned by
investors. In October 2004, it also began collecting a 1% fee on assets under management” (Lauricella
2009).

The 2G spectrum scamwas atelecommunications scam and political scandal in which politicians and
government officials under sold mobile companies’ licenses. The difference between the license fees
collected and that mandated to be collected was estimated by the Comptroller and Auditor General of
India at 1.76 trillion (US$26 billion). According to Central Bureau of Investigation, the loss was
estimated at around $ 309,845.5 million(US$4.6 billion). In reply to the CBI, the Telecom Regulatory
Authority of India (TRAI) said that the government had gained over $30 billion (US$450 million) by
selling 2G spectrum.Minister of Communications & IT KapilSibal said in a 2011 press conference that
"zero loss" was incurred by distributing 2G licenses on a first-come-first-served basis.The Supreme court
declared the allotment of spectrum "unconstitutional and arbitrary", cancelling the 122 licenses issued in
2008 under A. Raja (Minister of Communications & IT from 2007 to 2009). According to the court, Raja
"wanted to favour some companies at the cost of the public exchequer" and "virtually gifted away
important national assets.

Financial & Economic Impact Cases

As per study by ACFE approximately an organization loses 5% of its revenue each year. As per survey
undertaken by Communications fraud Control Association, 2015 (CFCA) Estimated Global Revenues
was $ 2.25 Trillion (USD) and Estimated Global Fraud Loss of $38.1 Billion (USD). When compared
with corruption and financial statements frauds, asset misappropriation has the least median losses but it
has highest offenders.

Overall frauds effects the productivity of an organization, demotivates others to perform their best and put
in their best efforts. It increases regulations, controls and surveillance which ultimately increase cost and
time.

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Detection

As examined by ACFE 2010 most number of frauds is created by men and age group of 31 to 50 years
old. As we examine reason is the men are more career oriented and have more desire to succeed than
women. Further age group of 31 to 50 is more likely for people as they various financial pressure and less
earning opportunity.

Further study of ACFE 2014 suggest most number frauds being committed into United States of America
and it is American business which gets most exposed to frauds. This is because America organizations are
most wealthiest and fraudsters seems to attack them they most as are likely to

According to ACFE 2014 report finds that the vast majority of fraud schemes are detected by tips
(42.2%), by management review (16%) or by accident (3.4%), external auditors.

Figure 2 Detection of fraud

Detection Technique of Asset Misappropriation

Occam Razor was theory of William Occam which claimed that for any study, conclusions are arrived on
the basis of facts and surrounding assumptions. If we eliminate the assumptions we are left with facts
which are more reliable. When we implement Razor Technique we are more emphasized in remaining
focused to the facts and not do get attracted to towards camouflage effects of fraudsters.

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Data Analysis, Surprise Audits, fraud vulnerability reviews, ethical hacking of system to test the IT
controls etc plays a pivotal role for detecting fraud.

Prevention

Fraud prevention is another area where there has been little academic research. What we do know is that
the major elements of fraud prevention are;

Traditional approaches will include have robust IT controls, segregation of duties, Internal Audits,
employees past history, security system etc.

For longer sustainable approach employers to create an ethical working place where rules are adhere by
all from top management to every employee of the company. Creating a culture of honesty, openness and
assistance for all employees and eliminating opportunities for fraud to occur.Creating awareness by
continues education and training of employees.

Organization should have whistleblower policy and hotline for reporting frauds. Further there should me
continues employees monitoring programs to keep check on physiological and financial health of
employees.

Conclusion

In conclusion, asset misappropriation is a very expensive problem for organizations. It is apparent from
the paper is that the risk of fraud is a byproduct of both personality and environmental or situational
variables.

We studied that very few organizations proactively address this problem due to materiality, which later
creates a reoccurring cycle of theft within many organizations.

By creating a proactive asset misappropriation policy, organizations can effectively assign responsibility
and greatly reduce their susceptibility to these schemes.

In conclusion, asset misappropriation is a very expensive problem for organizations. Best way to prevent
the fraud is to prevent it occurrence, once occurred perpetrator should not be spared and rightful action
and investigation should be done. Unfortunately, few organizations proactively address this problem,
which creates a reoccurring cycle of theft within many organizations. By creating a proactive asset
misappropriation policy, organizations can effectively assign responsibility and greatly reduce their
susceptibility to these schemes.

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References

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ACFE, “Report to the Nation on Occupational Fraud and Abuse,” The Association of Certified Fraud
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