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Fraud, whether committed by an employee who falsifies a time entry or one who embezzles funds, can destroy a company. Fraud can be catastrophic to a company’s operations, leading to significant business losses and civil and criminal penalties brought against the company and its leadership. And as we have seen recently, even mere allegations of fraud can have a devastating impact, often contributing to a company’s demise. Could these corporate catastrophes have been prevented? Recognizing the cost of fraud and the value of fraud prevention, companies are now looking to implement anti-fraud programs. But who in a company is the best person to implement and monitor a proactive anti-fraud program? An in-house counsel within the legal department who has investigative and compliance experience often fits the bill. However, an even better idea in terms of good corporate governance is to create a separate and independent position. This employee reports directly to the audit committee and has ultimate responsibility for the implementation and effectiveness of an anti-fraud program. We’ll call this position in-house compliance counsel. Too often, employees involved with compliance spend the majority of their working day putting out “fires.” They may have to ensure that disciplinary action is taken against a dishonest finance department employee who has made false journal entries in the company’s accounting system and intentionally inflated revenues. They may find another employee who has falsified her expense report. Once a problem is addressed, it is only a matter of time before another “fire” erupts. Recently, we have seen the consequences of fraudulent conduct at Tyco and WorldCom, whose “fires” were not extinguished until they caused considerable harm. Instead of expending large amounts of time reacting to corporate misconduct, a forward-thinking in-house compliance counsel should use a proactive approach to fraud prevention that creates an environment that rejects fraud and unethical behavior. But how to accomplish this, and where to begin? FRAUD RISK ASSESSMENT The initial step in creating an anti-fraud environment is for in-house compliance counsel to assess what kinds of anti-fraud policies a company already has in place. Next, compliance counsel should organize a team to conduct a formal fraud risk assessment. The assessment begins with a brainstorming process. What are the company’s fraud vulnerabilities? What are its anti-fraud controls? What needs to change? For example, failure to segregate duties often creates fraud risk. One employee, for instance, should not have responsibility for approving a wire transfer, creating the transfer documents, and executing the transfer. The situation becomes even more perilous if that same employee is responsible for accounting for the wire transfer. A comprehensive fraud risk assessment would identify this risk. In many companies, in-house compliance counsel leads the anti-fraud program and presides over a team, which should include an audit committee member. That person will share oversight responsibility for the program with the in-house compliance counsel. Other team members should include members from the business unit, accounting, internal audit, and finance departments. BACKGROUND INVESTIGATIONS A company can assess for fraud risk and maintain adequate fraud controls but still fall victim to fraud when it inadvertently hires an unethical employee. Although it is impossible to identify every individual who might commit fraud, a company which conducts a pre-employment background investigation can diminish the likelihood of bringing dishonest people into its workplace. In-house compliance counsel, working with the human resources department, should be thoroughly knowledgeable about the company’s hiring practices. Key employees should undergo a screening process that includes a comprehensive investigation using online resources, commercial databases, and public records. Information collected may include credit histories, civil judgments, bankruptcy filings, regulatory enforcement actions, and criminal histories. Moreover, background investigations should not be limited to new applicants. Employees who are promoted to positions of financial or operational responsibility or whose integrity is critical to the successful operations of the company, potential vendors, and business partners should also receive background inquiries to the full extent permitted by law. ETHICS EDUCATION Ethical principles are an essential ingredient of a corporate culture that values ethical conduct. Creating a strong ethical culture begins with providing employees with the tools to deal with dilemmas they may encounter in their workplace. Merely having a code of ethics will not ensure ethical behavior; a company needs to create a culture that supports ethical decision-making at all levels. That’s why in-house compliance counsel must have a thorough understanding of the company’s ethics policies and procedures, and should oversee periodic evaluations of the effectiveness of ethics training. In addition, counsel should make certain that the board of directors is fully aware of the ethics policies. To promote a strong ethical culture, in-house compliance counsel should ensure that the company: • Educates its employees about the company’s code of ethics

• Familiarizes employees with ethical decision-making models • Establishes an ethics help line with an ethics resource person • Conducts ethics risk assessments • Implements effective ethics policies and procedures • Conducts ethics discussion groups • Conducts periodic reviews of the treatment of unethical behavior FRAUD EDUCATION One of the key elements of an effective anti-fraud program is educating employees about the characteristics of fraud. Fraud is generally defined as an intentional act that results in a material misstatement in financial statements that are the subject of an audit. A fraud differs from an error in that it is an intentional act to deceive. A properly educated work force is the first line of defense in preventing and detecting fraudulent conduct. An effective fraud education program alerts employees to the potential for fraud, provides guidance on how to recognize fraud when it occurs, and explains what actions to take if they detect fraud. Virtually all employees should undergo some form of fraud education, and it should be customized to address daily fraud control responsibilities, such as the requirement to always obtain two signatures on a corporate check. To implement an effective fraud education program, in-house compliance counsel should assemble a core group of educational professionals who can teach the fraud curriculum to all levels of personnel. Additionally, vendors and business partners can be included. POLICIES, PROCEDURES, AND CONTROLS A company must establish policies and procedures that demonstrate an appropriate “tone at the top” and help guide employees to carry out their daily responsibilities in an ethical and lawful fashion. These should address subjects such as:

• Operational procedures

• Ethical business practices • Conflicts of interest • Reporting of alleged wrongdoing • Nonretaliation against whistle-blowers • Internal investigations • Corporate communications • Information security • Handling and retention of company documents Employees need clear guidance and a thorough understanding of their individual responsibilities. In-house compliance counsel, along with the human resources department, should establish frequent training sessions to ensure that all employees understand compliance. WHISTLE-BLOWER HOT LINE Implementing a whistle-blower hot line is a highly effective way to detect fraud both inside and outside the company. According to a 2004 study released by the Association of Certified Fraud Examiners, companies that had confidential reporting mechanisms reduced the amount of fraud losses significantly. The study included 508 cases of occupational fraud totaling more than $761 million in losses. According to the study, 60 percent of actual fraud reported originated through tips from employees, 20 percent from customers, 16 percent from vendors, and 13 percent from anonymous sources. It is critical that employees have confidence in the hot line’s integrity and in the company’s assurances of confidentiality and nonretaliation. In-house compliance counsel should take an active role in the creation of an anonymous hot line and oversee the investigation of tips. In addition, in-house compliance counsel should draft a whistle-blower policy, monitor how often the hot line is used, determine the nature of the calls to the hot line, and establish internal educational programs to communicate all aspects of the hot line to company employees. Lastly, an important aspect of a comprehensive anti-fraud program is prompt investigation of allegations of fraud and remediation of identified internal control weaknesses. MONITOR PROGRAMS Ongoing periodic monitoring, testing, and evaluation of the company’s anti-fraud program, together with its controls, policies, and procedures, is a key component of an effective fraud prevention program. The board of directors is responsible for overseeing the monitoring program and senior management for implementing it. In-house compliance counsel must know, and be able to demonstrate, that existing anti-fraud activities are effective. Furthermore, seemingly innocuous and insignificant changes in the company’s business plan and operational procedures can render some anti-fraud controls obsolete. Accordingly, an effective anti-fraud program must continually evolve with changes to the business structure and procedures. An effective anti-fraud program can not only diminish the likelihood of fraud, but it may also discourage the theft of corporate assets, diminish the likelihood of legal and regulatory actions, reduce the potential for adverse or qualified opinions by independent auditors, enhance investor confidence, and bolster the company’s reputation in the industry. Moreover, there is increasing evidence that investors, shareholders, insurers, and other stakeholders are willing to “reward” companies that take a proactive approach and implement effective anti-fraud activities. This is a major undertaking. While no two companies are exactly the same, it is essential that an effective anti-fraud program be tailored to meet each company’s specific needs. It may be necessary, then, for companies to seek the assistance of professional advisers and experts in their implementation of an anti-fraud program. In order to ensure the overall success of a company’s anti-fraud program, the board and senior management must assume a leadership role. For its part, an effective in-house compliance counsel can orchestrate the smooth functioning of the organization’s anti-fraud program by ensuring that participants do what they’re supposed to do. That way, in the future, in-house compliance counsel may have fewer “fires” to extinguish.


Glenn Pomerantz is a partner in BDO Seidman’s litigation and fraud investigation practice in New York and is the director of BDO’s anti-fraud program, which advises clients on preventing corporate fraud. Robin J. Zablow is a senior manager in BDO Seidman’s litigation and fraud investigation practice in New York.

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