Fraud Risk Management

D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E 1

Foreword

Instances of corporate fraud and misconduct remain a constant threat to public trust and confidence in the capital markets. As organizations strive to achieve compliance with an array of new antifraud laws and regulations that are not prescriptive on the design of controls in this area, management’s agenda is focusing on efforts to:

• Understand the fraud and misconduct risks that can undermine their business objectives
• Determine whether antifraud programs and controls are actually effective in reducing instances of fraud and misconduct
• Gain insight on better ways to design and evaluate controls to prevent, detect, and respond appropriately to fraud and misconduct
• Reduce exposure to corporate liability, sanctions, and litigation that may arise from violations of law or market expectations
• Derive practical value from compliance investments by creating a sustainable process for managing risk and improving performance
• Achieve the highest levels of business integrity through sound corporate governance, internal control, and transparency.

This white paper provides an overview of fraud risk management fundamentals, identifies new regulatory mandates from around the world, and spotlights key practices that organizations have generally found to be effective in the current environment.

We hope this perspective provides fresh insights as you consider the risks of fraud at home and abroad, and the effectiveness of controls you rely on to mitigate those risks.

E. BEN
C H I E F O F C O M M E R C I A L C R I M E B U R E A U

F R A U D R I S K M A N A G E M E N T 2

Executive Summary

In the wake of high-profile corporate scandals as well as new regulations worldwide, many business leaders are increasingly aware of the need to create company-specific antifraud measures to address internal corporate fraud and misconduct. While acknowledging that no single approach to fraud risk management can fit every organization’s needs, this white paper spotlights key practices that organizations have generally found to be effective when tailoring a company-specific antifraud program, and offers a strategic approach to aligning corporate values with performance.

The Business Imperative

As companies achieve compliance with new antifraud laws and regulations, their agendas center on management’s efforts to:
• Understand fraud and misconduct risks that can undermine their business objectives
• Reduce exposure to corporate liability, sanctions, and litigation

• Achieve the highest levels of business integrity through sound corporate governance, internal control, and transparency.

Fraud : Any intentional act committed to secure an unfair or unlawful gain.

Misconduct : A broad concept, generally referring to violations of law, regulations, internal policies, and market expectations of ethical business conduct.

Convergence of Regulatory Challenges

In recent years, a variety of laws and regulations have emerged worldwide, providing organizations with an array of criteria to incorporate into their antifraud efforts

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An effective, business-driven fraud risk management approach encompasses controls that have three objectives:
• Prevent. Reduce the risk of fraud and misconduct from occurring.
• Detect. Discover fraud and misconduct when it occurs.

• Respond. Take corrective action and remedy the harm caused by fraud or misconduct.

Pulling It All Together

The challenge for companies is to develop a comprehensive effort to:
• Understand all of the various control frameworks and criteria that apply to them.
• Categorize risk assessments, codes of conduct, and whistleblower mechanisms into corporate objectives.
• Create a broad ranging program that manages and integrates fraud prevention, detection, and response efforts.

An Ongoing Process

Effective fraud risk management provides an organization with tools to manage risk in a manner consistent with regulatory requirements as well as the entity’s business needs and marketplace expectations. Such an approach has four phases:
• Assess Risks. Identify the scope of the analysis and key stakeholders, profile the current state of fraud risk management, set targets for improvement, and define steps necessary to close the “gap.”
• Design. Develop a broad ranging program that encompasses controls to prevent, detect, and respond to incidents of fraud or misconduct.
• Implement. Deploy a strategy and process for implementing the new controls throughout the organization and assign responsibility for leading the overall effort to a senior individual.
• Evaluate. Assess existing controls compared with legal and regulatory frame-works as well as leading practices, such as internal investigation protocols or due diligence practices.

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Defining Fraud and Misconduct

Fraud is a broad legal concept that generally refers to an intentional act committed to secure an unfair orunlawful gain.Misconduct is also a broad concept, generallyreferring to violations of laws, regulations,
internal policies, and market expectations of ethical business conduct. Together, they fall into the following categories of risk that can undermine public trust and damage a company’s reputation for integrity:

• Fraudulent financial reporting (e.g., improper revenue recognition, overstatement of assets, understatement of liability)

• Misappropriation of assets (e.g., embezzlement, payroll fraud, external theft, procurement fraud,
royalty fraud, counterfeiting)

• Revenue or assets gained by fraudulent or illegal acts (e.g., over-billing customers, deceptive sales practices, accelerated revenue, bogus revenue)

• Expenses or liabilities avoided by fraudulent or illegal acts (e.g., tax fraud, wage and hour abuses, falsifying compliance data provided to regulators)

• Expenses or liabilities incurred for fraudulent or illegal acts (e.g., commercial or public bribery, kickbacks)

• Other misconduct (e.g., conflicts of interest, insider trading, discrimination, theft of competitor trade secrets, antitrust practices, environmental violations).

Scandals and failures, together with flourishing and cynical greed, may have profound and prolongedeffects on public opinions. It is our collective duty and well understood interest to demonstrate that market economy goes together with integrity and common good.

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Convergence of Regulatory
Challenges

Governments around the world have responded to corporate scandals and fraudulent activity by instituting legislative and regulatory reforms aimed at encouraging companies to become more self-governing. In recent years, a variety of laws and regulations have emerged, and the timeline in Figure 1 provides a selection of important global regulations and events.

Note also that a summary of relevant regulations appears in “Appendix: Selected International Governance and Antifraud Criteria” beginning on page 24.

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The key Objectives:
Prevention,Detection,Response

An effective, business-driven fraud and misconduct risk management approach is one that is focused on three objectives:

• Prevention: controls designed to reduce the risk of fraud and misconduct from occurring in the first place

• Detection: controls designed to discover fraud and misconduct when it occurs

• Response: controls designed to take corrective action and remedy the harm caused by fraud or misconduct

Putting It All Together

Just as there is an array of fraud and misconduct risks facing a company, there is an array of control criteria that various regulatory programs require companies to adopt. The challenge for companies, therefore, is to adopt a comprehensive and integrated approach that takes all relevant considerations into account and enables them to work together. Doing so helps avoid duplicative effort, resource fragmentation, and “slip-page between the cracks” associated with a one-off or silo approach.

Such an undertaking begins with understanding all of the various control frameworks and criteria that apply to the company (see Figure 2). When this categorization is complete, the organization has the information it needs to create a comprehensive program in which the elements of prevention, detection, and response can be integrated and managed

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Lists sample elements of a comprehensive program designed to prevent, detect and respond to fraud.

Sample Antifraud Program Elements.

Prevention	Detection	Response
	Board/audit committee oversight Executive and line management functions Internal audit, compliance, and monitoring functions
• Fraud and Misconduct Risk Assessment • Code of conduct and Related standards • Employee and Third-party Diligence • Communication and Training • Process-specific fraud Risk controls	• Hotlines and Whistle-blower Mechanisms • Auditing and Monitoring • Proactive Forensic Data Analysis	• Internal Invivestigation Protocols • Enforcement and Accountability Protocols • Disclosure Protocols • Remedial Action Protocols

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Prevention

Preventive controls are designed to help reduce the risk of fraud and misconduct from occurring in the first place

Leadership and Governance

Board/Audit Committee Oversight

An organization’s board of directors plays an important role in the oversight and implementation of controls
to mitigate the risk of fraud and misconduct. The board, together with management, is responsible for
setting the “tone at the top” and ensuring institutional support is established at the highest levels for ethical
and resposible business practices.

Directors have not only a fiduciary duty to ensure that an organization has programs and controls in place to address the risk of wrongdoing but also a duty to ensure that such controls are effective.

As a practical matter, the board may delegate principal oversight for fraud and misconduct risk management to a committee (typically audit), which is tasked with, among other things:

• Reviewing and discussing issues raised during the entity’s fraud and misconduct risk assessment
• Reviewing and discussing with the internal and external auditors findings on the quality of the organization’s antifraud programs and controls
• Establishing procedures for the receipt and treatment of questions or concerns regarding questionable accounting or auditing matters.

^{A robust fraud strategy is one that is sponsored at the highest level within a firm and embedded within the culture. Fraud threats are dynamic and fraudsters constantly devise new techniques to exploit the easiest target.}

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Senior Management Oversight

To help ensure that fraud and misconduct controls remain effective and in governmental standards, responsibility for the organization’s fraud and risk management approach should be shared at senior levels (i.e., individuals with substantial control or a substantial role in policy-making). This critical oversight begins with prevention and must also be part of detection and response efforts.

The chief executive officer is ideally positioned to influence employee actions through his or her executive leadership, specifically by setting the ethical tone of the organization and playing a crucial role in fostering a culture of high ethics and integrity. For instance, the chief executive can lead by example, allocating resources to antifraud efforts and holding senior management accountable for compliance violations.

Direct responsibility for antifraud efforts should reside with a senior leader, often a chief compliance officer who works together with internal audit staff and designated subject matter experts. The chief compliance officer is responsible for coordinating the organization’s approach to fraud and misconduct prevention, detection, and response. When fraud and misconduct issues arise, this individual can draw together the right resources to deal with the problem and make necessary operational changes. The chief compliance officer may also chair a committee of cross-functional managers who:

• Coordinate the organization’s risk assessment efforts

• Establish policies and standards of acceptable business practice
• Oversee the design and implementation of antifraud programs and controls • Report to the board and/or the audit committee on the results of the organization’s fraud risk management activities.

Other business leaders such as department heads (e.g., product development, marketing, regulatory affairs, human resources) should also participate in responsibilities under the organization’s antifraud strategy; they oversee areas of daily operations in which risks arise. Such department heads can serve as subject matter experts to assist the chief compliance officer with respect to their particular areas of expertise or responsibility.

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Internal Audit Function

The modern organization’s internal audit function is a key participant in antifraud activities, supporting management’s approach to preventing, detecting, and responding to fraud and misconduct. RIS’s 2003 Fraud Survey notes that 65 percent of respondents indicated that frauds were uncovered through the work of internal audit. Such responsibilities represent a change from the more traditional role of internal audit (that is, examining the effectiveness of the entity’s controls). In general, internal audit should be responsible for:The modern organization’s internal audit function is a key participant in antifraud activities, supporting management’s approach to preventing, detecting, and responding to fraud and misconduct. RIS’s 2003 Fraud Survey notes that 65 percent of:

• Planning and conducting the evaluation of design and operating effectiveness of
antifraud controls

• Assisting in the organization’s fraud risk assessment and helping draw conclusions
as to appropriate mitigation strategies

• Reporting to the audit committee on internal control assessments, audits,

investigations, and related activities.

Fraud and Misconduct Risk Assessment

All organizations typically face a variety of fraud and misconduct risks. Like a more conventional entity-wide risk assessment, a fraud and misconduct risk assessment helps management understand the risks that are unique to its business, identify gaps or weaknesses in control to mitigate those risks, and develop a practical plan for targeting the right resources and controls to reduce risk.

Management should ensure that such an assessment is conducted across the entire organization, taking into consideration the entity’s significant business units, processes, and accounts.

With input from control owners as to the relevant risks to achieving organizational objectives, a fraud and misconduct risk assessment includes the following steps of:

Fraud Risk Assessment Process

Identify Business Units, Locations or Processes to Assess

Inventory and categorize Fraud/Misconduct Risk or Occurrences

Rates Risks based on the likelihood and Significance of occurrence

Remediate Risks through Control Optimization

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While management is responsible for performing a targeted risk assessment process and considering its results in evaluating control effectiveness, the audit committee typically has an oversight role in this process. The audit committee is responsible for reviewing management’s risk assessment, ensuring that it remains an ongoing effort, and interacting with the entity’s independent auditor to ensure that assessment
results are properly communicated.

Code of Conduct

An organization’s code of conduct is one of the most important communications vehicles that management can use to communicate to employees on key standards that define acceptable business conduct. A well-written and communicated code goes beyond restating company policies such a code sets the tone for the organization’s overall control culture, raising awareness of resources available to help employees achieve management’s compliance goals. A well-designed code of conduct typically includes:

• High-level endorsement from the organization’s leadership, underscoring a commitment to integrity

• Simple, concise, and positive language that can be readily understood by all employees

• Topical guidance based on each of the company’s major policies or compliance risk areas

• Practical guidance on risks based on recognizable scenarios or hypothetical examples

• A visually inviting format that encourages readership, usage, and understanding

• Ethical decision-making tools to assist employees in making the right choices

• A designation of reporting channels and viable mechanisms that employee can use to report concerns or seek advice without fear of retribution.

52%

Percentage of U.S. employees

who reported that their codes of

conduct are not taken seriously.

RIS Forensic Integrity Survey

2005 - 2006

I submit that having a code of ethics that is not vigorously implemented is worse than not having a code of ethics. It smacks of hypocrisy.

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Employee and Third-Party Due Diligence

An important part of an effective fraud and misconduct prevention strategy is the use of due diligence in the hiring, retention, and promotion of employees, agents, vendors, and other third parties. Such due diligence may be especially important for those employees identified as having authority over the financial reporting process.

49%

Percentage of U.S. employees who reported that they would
be rewarded based on results, not the means used to achieve
them. RIS Forensic Integrity Survey2005 – 2006

The scope and depth of the due diligence process typically varies based on the organization’s identified risks, the individual’s job function and/or level of authority, and the specific laws of the country in which the organization resides.

There are certain situations where screening third parties may be valid. For example, management may wish to screen agents, consultants, or temporary workers who may access confidential information or acquisition targets that may have regulatory or integrity risks that can materially affect the value of the transaction.

Due diligence begins at the start of an employment or business relationship and continues throughout. For instance, taking into account behavioral considerations— such as adherence to the organization’s core values—in performance evaluations provides a powerful signal that management cares about not only what employees achieve but also that those achievements were made in a manner consistent with the company’s values and standards.

Communication and Training

Making employees aware of their obligations concerning fraud and misconduct control begins with practical communication and training. While many organizations communicate on such issues in an ad hoc manner, efforts taken without planning and prioritization may fail to provide employees with a clear message that their control responsibilities are to be taken seriously.

55%

Percentage of U.S. employees who reported

that they lacked understanding of the standards
of conduct that applies to their jobs.

RIS Forensic Integrity Survey

2005 - 2006

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In formulating a training and communications plan, management should consider developing fraud and misconduct awareness initiatives that are:

• Comprehensive and based upon job functions and risk areas

• Integrated with other training efforts, whenever possible

• Effective in a variety of settings, using multiple methods and techniques

• Regular and frequent, covering the relevant employee population.

Senior management must move from thinking about compliance as chiefly a cost center to considering the benefits of compliance in protecting against the legal and reputational risks that can have an impact on the bottom line.

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Detection

Detective controls are designed to uncover

Fraud and Misconduct when it occurs

Mechanisms for Seeking Advice and Reporting Misconduct

With the oversight and guidance of senior management, organizations tend to provide employees with multiple channels for reporting concerns about fraud or misconduct. Many typically request that employees follow a process that would begin with alerting their own managers, if possible, or a designated human resources or compliance officer. Telephone “hotlines” are often made available and can be used at any time, although they are usually intended for use when the normal channels are impractical or ineffective.

A hotline typically provides a viable method whereby employees, and other third-parties if applicable, are encouraged to:

• Communicate concerns about potential fraud and misconduct, including questionable accounting or auditing matters

• Seek advice before making decisions when the appropriate course of action is unclear.

A well-designed hotline typically includes the following features:

• Confidentiality. All matters reported via the hotline are treated confidentially. Hotline operators inform callers that their concerns will be reported only on a “need to know” basis and that relevant safeguards are in place to ensure that such confidentiality is maintained. Hotline operators notify callers if the confidentiality of the matter is subject to any legislative limitations.

• Anonymity. The organization’s protocols allow for the anonymous submission and resolution of calls. For instance, callers who wish to remain anonymous are given a case tracking number that they can later use to provide additional details related to their question or allegation and/or check the status or outcome of their call.

• Organization-wide Availability. Employees at international locations are able to use the hotline through features such as real-time interpreting and toll-free call routing.

• Real Time Assistance. The hotline is designed to provide an immediate, “live” response to a call to facilitate thorough and consistent treatment of a caller’s question or concern as well as to provide immediate guidance. Thus, hotline operators need to be appropriately qualified, trained, and, in some situations, authorized to provide advice.

• Data Management Procedures. The hotline operator uses consistent protocols for gathering relevant facts and managing the hotline calls.

• Classification of Financial Reporting Concerns. The hotline includes protocols whereby qualified individuals (e.g., internal audit, legal, security) can determine whether the nature of an allegation could trigger a financial reporting risk.

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• Audit Committee Notification. The hotline includes protocols that specify the nature and timing of allegations that are escalated to the audit committee.

• Follow-up on Non-retaliation. The organization’s protocols allow for following up with employees periodically after the hotline case has been closed (e.g., at one, three, six-month intervals) to ensure that reporting employees have not experienced retaliation. The company encourages the employees to report any instances of retaliation and takes swift action against those who do retaliate.

• Prominent Communications. The organization publicizes its hotline prominently. Such communications may include, among others, (1) describing the hotline within the code of conduct and other key company publications and training; (2) displaying the hotline telephone number on posters, banners, wallet cards, screen savers, telephone directories, or desk calendars; and (3) communicating mini-case-studies based on hotline calls to employees (e.g., in newsletters, training programs, or intranet sites) to demonstrate that the organization values hotline calls and is able to provide assistance to those who use the hotline.

Auditing and Monitoring

Auditing and monitoring systems that are reasonably designed to detect fraud and misconduct are important tools that management can use to determine whether the organization’s controls are working as intended. Since it is impossible to audit every fraud and misconduct risk, management should develop a comprehensive auditing and monitoring plan that is based on risks identified through the organization’s fraud risk assessment process.

33%

Percentage of Australia/New

Zealand employees reporting

that early warnings of fraud

problems were ignored.

RIS Fraud Survey 2004

An auditing and monitoring plan should thus encompass activities that are tailored in depth to the nature and degree of the risk involved, with higher-risk issues receiving priority treatment. Auditing activities (an evaluation of past events) and monitoring activities (an evaluation conducted real-time) should be performed in, but are not limited to, areas where:

• There are specific concerns about a key procedure, account, or position

• The company has a history of fraud and misconduct

• There is high employee turnover or organizational change

• Laws and regulations have changed significantly

• Audits are legally required, or governmental agencies are targeting enforcement actions.

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An organization’s managers involved in auditing and monitoring efforts should not only have sufficient training and experience but also be seen as objective in evaluating the controls for which they are responsible. Optimally, auditing and monitoring protocols should:

• Occur in the ordinary course of operations, including during regular management and supervisory activities

• Draw on external information to corroborate internally generated information

• Formally communicate identified deficiencies and exceptions to the organization’s senior leadership, so that the harm to the organization is appropriately understood and mitigated

• Use results to enhance and modify other controls, such as communications and training, performance evaluations, and discipline.

Proactive Data Analysis

• Occur in the ordinary course of operations, including during regular management and supervisory activities

• Draw on external information to corroborate internally generated information

• Formally communicate identified deficiencies and exceptions to the organization’s senior leadership, so that the harm to the organization is appropriately understood and mitigated

• Use results to enhance and modify other controls, such as communications and training, performance evaluations, and discipline.

Many of the indicators of fraud and misconduct, both actual and potential, reside within an organization’s financial, operational, and transactional data, and can be identified using data analysis tools and techniques. Such proactive data analysis uses sophisticated analytical tests, computer-based cross matching, and non-obvious relationship identification to highlight potential fraud and misconduct that can remain unnoticed by management, often for years. The benefits of such an analysis may include, among others:

• Identification of hidden relationships between people, organizations, and events

• A means to analyze suspicious transactions

• An ability to assess the effectiveness of internal controls intended to prevent or detect fraudulent activities

• The potential to continually monitor fraud threats and vulnerabilities

• The ability to consider and analyze thousands of transactions in less time, more efficiently, and cost-effectively than using more traditional forensic sampling techniques

• The ability to consider a company’s unique organizational and industry issues.

Transactions can be analyzed using either retrospective or continuous transaction monitoring. Retrospective analyses allow organizations to analyze transactions in one or two year increments, enabling organizations to discern patterns that are not visible with shorter term analyses. Creating the capability to perform retrospective-based proactive forensic data analysis includes steps to:

• Assess the fraud risk profile of systems or processes

• Define the overall objectives of the analysis

• Create a methodology to acquire, extract, and evaluate the data

• Define the analyses to be performed

• Select software tools to be used in performing the analysis

• Perform the analysis, aggregate and prioritize the results, and review and resolve the exceptions identified.

Unlike retrospective-based analyses, continuous transaction monitoring allows an organization to identify potentially fraudulent transactions on, for example, a daily, weekly, or monthly basis. Organizations frequently use continuous monitoring efforts to focus on narrow bands of transactions or areas that pose particularly strong risks.

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Response

Response controls are designed to take corrective action and
remedy the harm caused by fraud or misconduct.

Investigations

When information relating to actual or potential fraud and misconduct is uncovered, management should be prepared to conduct a comprehensive and objective internal investigation. The purpose of such an investigation is to gather facts leading to a credible assessment of the suspected violation, so management can decide on a sound course of action.

By conducting an effective internal investigation, management can address a potentially troublesome situation and have an opportunity to avert a potentially intrusive government investigation. A well-designed investigative process will typically include the following attributes, among others:

• Oversight by the organization’s audit committee, or a special committee of the

board, either of which must comprise independent directors who are able to ward off undue pressure or interference from management

• Direction by outside counsel, selected by the audit committee, with little or no ties to the entity’s management team, and that can perform an unbiased, independent, and qualified investigation

• Vetting by the organization’s external auditor so that the latter can rely on the
proposed scope of work in the audit of the organization’s financial statements

• A full-cooperation requirement, allowing no employee or member of management to obscure the facts that gave rise to the investigation

• Reporting protocols, providing the external auditors, regulators, and, where appropriate, the public with information relevant to the investigation’s findings in a spirit of cooperation and transparency.

Based on a number of factors, including the nature of the potential illegal act, parties involved, and materiality, the organization may decide to use one or more of the above steps. Management would consult with the appropriate oversight functions and internal protocols to determine the steps that best address the allegation.

47%

Percentage of U.S. employees

who reported that wrongdoers
would be disciplined fairly
regardless of their position.

RIS Forensic Integrity Survey

2005 - 2006

Enforcement and Accountability

A consistent and credible disciplinary system is a key control that can be effective in deterring fraud and misconduct. Appropriate discipline is, additionally, a requirement under leading regulatory frameworks. By mandating meaningful sanctions, management can send a signal to both internal and external parties that the organization considers managing fraud and misconduct risk a top priority.

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A well-designed disciplinary process will be communicated to all employees and include company-wide guidelines that promote:

• Progressive sanctions consistent with the nature and seriousness of the offense (e.g., verbal warning, written warning, suspension, pay reduction, location transfer, demotion, or termination)

• Uniform and consistent application of discipline regardless of rank, tenure, or job function.

Holding managers accountable for the misconduct of their subordinates is another important consideration. Managers may be disciplined in those instances where they knew, or should have known, that fraud and misconduct might be occurring, or when they:

• Directed or pressured others to violate company standards to meet business objectives or set unrealistic goals that had the same effect

• Failed to ensure employees received adequate training or resources
• Failed to set a positive example of acting with integrity or had a prior history of missing or permitting violations

• Enforced company standards inconsistently or retaliated against others for reporting concerns.

Corrective Action

Once fraud and misconduct has occurred, management should consider taking action to remedy the harm caused. For example, management may wish to consider taking the following steps, among others, where appropriate:

• Voluntarily disclosing the results of the investigation to the government or other relevant body (i.e., a regulator)

• Remedying the harm caused

• Examining the root causes of the relevant control breakdowns, ensuring that risk is mitigated and that controls are strengthened

• Administering discipline to those involved in the inappropriate actions as well as to those in management positions who failed to prevent or detect such events

• Communicating to the wider employee population that management took appropriate, responsive action.

63%

Percentage of Australian/New
Zealand organizations that
reported the incident to the police.

RIS Fraud Survey 2004

Although public disclosure of fraud and misconduct may be embarrassing to an organization, management may nonetheless wish to consider such an action in order to combat or preempt negative publicity, demonstrate good faith, and assist in putting the matter to rest.

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To Charge or Not to Charge?

In deciding not to charge Seabord Corporation with violations of the federal securities laws following an investigation of alleged accounting irregularities, the SEC announced influential dictum that a company’s self-policing, self-reporting, remediation, and cooperation with law enforcement authorities, while no guarantee for leniency, would factor into the prosecutorial decision making process. Among other questions the SEC would be asking the following:

• Did the company promptly, completely, and effectively disclose the existence of the misconduct to the public, to regulators, and to self-regulators?

• Did the company cooperate completely with appropriate regulatory and law enforcement bodies?

• Did the company appropriately recompense those adversely affected by the conduct?

• Did it do a thorough review of the nature, extent, origins, and consequences of the conduct and related behavior?

• Did the company promptly make available to our staff the results of its review and provide sufficient documentation reflecting its response to the situation?

• Did the company voluntarily disclose information our staff did not directly request and otherwise might not have uncovered?

• Did the company ask its employees to cooperate with our staff and make all reasonable efforts to secure such cooperation?

Accounting and Auditing Enforcement, Exchange Act Release No. 44,969 (October 23, 2001). The release may be found at www.sec.gov/litigation/investreport/34-44969.htm.

To Fine or Not to Fine?

In a related opinion on January 4, 2006, the SEC opined that in deciding the appropriateness of a civil monetary penalty levied against a corporate settlement of action, the following factors would be examined:

• The presence or absence of a direct benefit to the corporation as a result of the violation.

• The degree to which the penalty will recompense or further harm the injured shareholders.

• The need to deter the particular type of offense.

• The extent of the injury to innocent parties.

• Whether complicity in the violation is widespread throughout the corporation.

• The level of intent on the part of the perpetrators.

• The degree of difficulty in detecting the particular type of offense.

• Presence or lack of remedial steps by the corporation.

• Extent of cooperation with Commission and other law enforcement.

Statement of the Securities and Exchange Commission Concerning Financial Penalties, Release 2006-4 (January 4, 2006). The Statement may be found at http://www.sec.gov /news/press/2006-4.htm.

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An Ongoing Process

An effective fraud risk management approach provides an organization with tools to help manage risk in a manner consistent with regulatory requirements as well as the entity’s business needs and marketplace expectations. As described below, developing such an approach can be achieved in key phases:

• Assessment of Risks: Assessing the needs of the organization based on the nature of fraud and misconduct that risk controls are intended to mitigate and the adequacy of existing controls.

• Design: Developing controls to prevent, detect, and respond to identified risks in a manner consistent with legal and regulatory criteria and other leading practices.
• Implementation: Deploying a process for implementing the new controls and assigning responsibility to individuals with the requisite level of authority, objectivity, and resources to support the process.

• Evaluation: Evaluating the design and operating effectiveness of controls through control self-assessment, substantive testing, routine monitoring, and separate evaluations.

Assessment

The nature of fraud and misconduct risks facing an organization can be as diverse and fluid as the business itself. The risks of fraud and misconduct for a national bank that has experienced rapid growth through acquisitions are different than those of a global energy company seeking to expand crude exploration in emerging markets. Therefore, antifraud measures should be tailored to the unique risks of an organization, the specific conditions that give rise to those risks, and the targeted resource needs required in balancing risk and control.

The first step is to determine what a company’s fraud risks are and how effectively the organization manages these risks. To get started, an organization would consider which business units, processes, systems, and controls, among other factors, may need to be included in the scope of the analysis. The organization can also identify key stakeholders who may need to be involved. Once the organization profiles its current state and sets targets for improvements, it can assess the “gap” it must close to reach the desired state and begin defining the necessary steps to get there.

Design

The goal of the control design phase is for management to develop controls that will operate effectively and protect the organization from the risk of fraud and misconduct. However, for an entity to design effective controls, it must first tailor these controls to the risks it is facing as well as the organization’s unique business environment.