Helping Communities Identify Red Flags

CFEs are the front line in the battle against fraud. We relentlessly identify and investigate fraud and financial malfeasance and educate ourselves about the nuances of fraud, the most recent schemes and the best investigative skills. However, we should also educate those we know. This column explores the red flags that we, as new and budding fraud examiners (and veterans), can teach our families, friends, coworkers, employees, managers and communities to look for when they engage in business and social dealings.

A RED FLAG PRESENTS ITSELF 

In this fictitious case, Sue, a Certified Fraud Examiner and an employee in a bank's human resources department, conducts a background investigation on Gary, who is applying for a job as a senior loan officer. During an interview with one of Gary's neighbors, Sue notices that Gary had recently purchased a new, in-ground pool. When she casually asks Gary about it, he shrugs it off. "My mother-in-law gave us the money," he says. Sue's sixth sense tells her that there is something more to this story — Gary's résumé indicates he was unemployed in the previous year after another bank let him go because of the economic decline. She pulls records that show Gary's wife had declared bankruptcy six months before, and Gary's creditors stated he was delinquent on three loans. Sue knows she needs to discuss this case with her supervisor. She had learned about fraud red flags from in-house anti-fraud training, the ACFE annual fraud conference and from her experience working on cases. Now Sue is able to put her education into practice. 

 WAVING THE RED FLAG 

Red flags, of course, are the clues that lead us to determine if illicit activity might be occurring. Our duty is to identify these flags and conduct full examinations — due diligences — to either verify or refute the hypotheses. 
 CFEs also fight fraud by educating other employees, co-workers, friends, family and the general public about these fraud indicators.
 
 As Donald Cressey explained in his seminal book, "Other People's Money: A Study in the Social Psychology of Embezzlement" (Patterson Smith, 1973), there are many types of embezzlers. Those who embezzle to fix a short-term financial problem (such as a business failure or home foreclosure) can eventually be drawn into a long-term scheme to maintain their new, wealthier lifestyle.
 
The earmarks of embezzlement often are small things that, at first glance, often look normal. Of course, every case will be different, and many red flags will vary according to an organization, its culture and controls, and the suspect's position, reputation, history, current financial status, financial skill, education level and access.  

A CLUE CAN BE MISLEADING 

 Don't jump to conclusions when you observe a red flag and accuse someone of a crime. Instead, follow the thread to see if it leads you to other flags. If it does, discuss your suspicions with a senior examiner or supervisor.
 
Be thorough, accurate and precise when you follow up on the flags. Spend time writing your initial and subsequent questions to responses. If possible, record all testimonies and statements under oath. Collect, examine and analyze documents, and follow each lead to its logical conclusion. Be professionally skeptical. Seemingly coincidental events often are helpful hints for the investigation.  
Let's examine some of the best red flags for embezzlement — a common occupational fraud. (By the way, according to the ACFE's Fraud Examiners Manual, embezzlement is defined as the "wrongful taking or conversion of the property of another for the wrongdoer's benefit.") 

BE WARY OF LARGE CASH TRANSACTIONS 

In today's e-banking business environment, credit and debit cards have almost replaced cash. Those who carry and use large amounts of cash might be trying to avoid a paper trial that could lead to a crime. (Though there are some honest citizens who still don't trust banks.)  
Use of cash to do business that would otherwise be handled by more conventional means, such as loans, credit cards or a combination of methods, should immediately raise questions. Some purely cash businesses are wholly illicit such as drug dealing or the sale of fraudulent identification documents. 

LOOK FOR LIFESTYLE CHANGES 

The book "Traitors Among Us," by U.S. Army Col. Stuart Harrington, describes the investigation of Sergeant Clyde Conrad who was discovered selling information to the Soviet Union for a sizeable fortune. Conrad's nickname was "Poor Clyde" because his Army colleagues often had to loan him a few dollars for lunches. But his fortunes seemed to reverse almost overnight. Clyde's children now wore the most fashionable clothes. He would buy rounds of drinks for his friends at the bar. Clyde suddenly bought some of the most expensive and rarest coins for his collection.  
A sudden change in affluence (going from need to greed) is often the first sign that someone is embezzling. Often, when these folks are pressed about the details of their sudden wealth, they will give a concocted story. (In the July/August column, we will describe strategies to defeat these tall tales.) 

WATCH THOSE WHO REFUSE TO TAKE OFF TIME 

Some live to work, but many others work primarily so they can enjoy their families, hobbies, friends and the other experiences of life. So they normally take vacations or sick days. Watch those employees who never take these benefits. Many companies have discovered workers' embezzlements when their managers have forced them to take time off, and other employees pick up their jobs and discover irregularities. Requiring everybody to take vacations is an effective internal control.

FURTHER RESOURCES 

There are a million and one red flags of embezzlement and other fraudulent activities. (See more in the sidebar below.) You can learn more about red flags in: 

The ACFE's "Fraud Examiners Manual" 

"Corporate Fraud Handbook: Prevention and Detection," by Dr. Joseph T. Wells, CFE, CPA, the founder and Chairman of the ACFE

"Fraud Examination, Fourth Edition," by W. Steve Albrecht, Conan C. Albrecht, Chad O. Albrecht and our own Mark F. Zimbelman 

"Fraud Auditing and Forensic Accounting, Second Edition," by G. Jack Bologna and Robert Lindquist

When you read publications such as Fraud Magazine, the Journal of Accountancy or The CPA Journal, try to identify some red flags in the articles' case histories that you can share in your presentations, writing or when talking with others from all walks of life.  

TIMING IS EVERYTHING 

When you educate others about red flags, emphasize the importance of recognizing their coworkers' vulnerabilities. Even good people can succumb to fraud when pressure and opportunity are high. So the timing of risk factors is vital to identifying and preventing fraud. Employees might have discovered an individual's vulnerability and helped them in his or her time of need, thus preventing a fraud and a costly investigation and mitigation. 
Let us say, a woman who is the bookkeeper for a small office has lost her husband to suicide. Her bank repossesses her car a few weeks later. With this pressure and a perceived opportunity, she begins to embezzle to make ends meet. However, if a colleague or two had been perceptive, they could have helped the bookkeeper before she made a rash decision in a weak moment. 
THE NEXT STEP: EXCUSES, EXCUSES 

 In our next column, we'll return to Sue's quest for the truth about Gary and his financial problems. Clearly, she's identified several red flags: a recent large purchase, financial distress, bankruptcy and a long unemployment. What does Sue do next?   

Also, in the July/August column, we will explore the issue of "financial defenses." We'll discuss how to debunk fraudsters' lies, half-truths and misdirections. 

Colin May , CFE, M.S., is a forensic financial investigator with a government agency (the views in Starting Out are his own) in Baltimore, Md. 

Mark F. Zimbelman, Ph.D., CPA, Educator Associate Member, is the Selvoy J. Boyer Fellow and professor of accounting at Brigham Young University in Provo, Utah. 

SIDEBAR 

Be Aware of Additional Red Flags:

Large mortgage/second mortgage/vacation houses/home improvements

Inordinate amount of vacations and travel

Collector/vintage automobiles

Boats

Airplanes

Private Schools

Maids/servants

Diamond and jewels

Commodities

Off-shore investments

Foreign property

Foreign business interests

Expensive clothing

Always paying the tab for lunch, happy hour, etc.

Gift giving

Claims of inheritance or large cash winnings

Stock market or day-trading dealings

Unusually high revolving credit with no overdue amounts

 Large debts paid off successfully and/or quickly with a relatively low salary 

 Any credible report that the subject has attempted to hide income or assets 

Explanations of wealth are vague, inconsistent or uncharacteristic 

Based upon "Finances — Affluence" in the U.S. Department of Defense's "Adjudicative Desk Reference," by R.J. Heuer. 

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