Fraud Tree components

As discussed in my previous blog, here I am trying to write on basic components as forms the Fraud Tree.

1) BRIBERY AND CORRUPTION

Generally, bribery and corruption are off-book frauds that occur in the form of kickbacks, gifts, or gratuities to government employees from contractors or to private business employees from vendors.

At its heart, a bribe is a business transaction, albeit an illegal or unethical one. A person “buys” something with the bribes he pays. What he buys is the influence of the recipient.

Bribery schemes can be difficult and expensive. Though they are not nearly as common as other forms of occupational fraud such as asset misappropriations, bribery schemes tend to be much more costly.

There are two basic reasons why a bribe occurs:

• Because the transaction is not in the interests of the organisation for whom the person being bribed acts. Therefore, if the other party wants the transaction to be effected, it is necessary to bribe that person.

• Although the person receiving the bribe may be acting in the best interests of his organisation by agreeing/approving the transaction, he may refuse to act until he has received the bribe. This may be the convention of the industry/country in which he is operating and accepted by the person offering the bribe not as immoral but as a necessary expense and in the interests of his own organisation.

Bribery is often defined as the offering, giving, receiving, or soliciting any thing of value to influence an official act. The term official act means that bribery only encompasses payments made to influence the decisions of government agents or employees.

Many occupational fraud schemes, however, involve commercial bribery, which is similar to the traditional definition of bribery except that something of value is offered to influence a business decision rather than an official act of government.

Bribery schemes generally fall into two broad categories:

1.1 kickbacks and

1.2 bid-rigging schemes

1.1 Kickback Schemes:

Kickbacks are undisclosed payments made by vendors to employees of purchasing companies. The purpose of a kickback is usually to enlist the corrupt employee in an overbilling scheme. Sometimes vendors pay kickbacks simply to get extra business from the purchasing company

Kickbacks are classified as corruption schemes rather than asset misappropriations because they involve collusion between employees and vendors. In a common type of kickback scheme, a vendor submits a fraudulent or inflated invoice to the victim organisation and an employee of that organisation helps make sure that a payment is made on the false invoice. For his assistance, the employee-fraudster receives a payment from the vendor. This payment is the kickback.

Kickback schemes almost always attack the purchasing function of the victim company, so it stands to reason that these frauds are often undertaken by employees with purchasing responsibilities.

1.2 Bid-rigging Schemes

Bid-rigging schemes occur when an employee fraudulently assists a vendor in winning a contract through the competitive bidding process. The competitive bidding process, in which several suppliers or contractors are vying for contracts in what can be a very cutthroat environment, is tailor made for bribery. Any advantage one vendor can gain over his competitors in this arena is extremely valuable. The benefit of “inside influence” can ensure that a vendor will win a sought-after contract. Many vendors are willing to pay for this influence

1.2.A The Pre-solicitation Phase

In the pre-solicitation phase of the competitive bidding process—before bids are officially sought for a project—bribery schemes can be broken down into two distinct types. The first is the need recognition scheme, where an employee of a purchasing company is paid to convince his company that a particular project is necessary. The second reason to bribe someone in the pre-solicitation phase is to have the specifications of the contract tailored to the strengths of a particular supplier.

1.2.B Bid Pooling

Bid pooling is a process by which several bidders conspire to split contracts up and assure that each gets a certain amount of work. Instead of submitting confidential bids, the vendors discuss what their bids will be so they can guarantee that each vendor will win a share of the purchasing company’s business.

Fraud Tree

Fraud has been classified in two broad categories: a) Internal Fraud and b) External Fraud.

Internal Frauds, are generally committed by an employee / executive / manager in an organisation to benefit himself at cost of organisation. This Internal Fraud can also be said as an Occupational Fraud.
Occupational Fraud if further classified in three categories:
i) Corruption
ii) Asset Misappropriation
iii) Financial Statement Fraud

These three classifications along with its sub categories is termed as Fraud Tree.

I would explain each category in details in subsequent blog.

Fraud Scale

After basic understanding on Fraud Triangle theory by Donald R. Cresssey, we need to understand one more theory as pronounced by Dr. Steve Albercht - "Fraud Scale" theory.

Dr. Steve was a pioneer researcher in occupational fraud and abuse. Like Cressey's study, Albercht study suggests there are three factors involved in occupational frauds:
1) Situational Pressure
2) Opportunities to Commit
3) Personal Integrity

To illustrate this concept, he developed 'Fraud Scale' as below which includes the three components:

All components are scaled from High to low. First two components: Situational Pressure and Opportunity to Commit is directly proportionate to Fraud, where as Personal Integrity is inversely proportionate to Fraud.

What is Forensic Audit?

Before understanding what is Forensic Audit, I would define few basic terminologies so understanding becomes gradual and more clear. 

Fraud:

Intentional perversion of truth for the purpose of inducing another to part with something valuable

- Black's Law Dictionary

Thus we may say that there are three elements in 'fraud'

A) Intent to deceive, B) Materiality, C) Damage

Forensic

Word forensic has been arrived from Latin adjective 'forensis', this means 'of or before the forum'

Thus Forensic Audit is a process of reviewing an entity's (Company/Individual/any person) financial statements to determine the accuracy and its lawfulness and the same can withstand in court-of-law.