Detecting Fraud in Public Service Organizations

By Kevin M. Bronner

Fraud schemes have become a significant issue for many public service organizations. During November 2013, the Rockefeller Institute at the University at Albany conducted a special presentation concerning fraud issues in the public sector. The New School in New York City also conducted a corruption conference in November 2013. Other organizations, such as the Association of Certified Fraud Examiners (ACFE) and the American Institute of Certified Public Accountants (AICPA) have studied fraud issues for many years. In fact, the ACFE presents a study every two years outlining how to find fraud. The latest study, titled “Report to the Nations on Occupational Fraud and Abuse 2012 Global Fraud Study,” indicates that approximately 5 percent of the revenues of an organization are subject to fraud. This means that for every $100 billion of public spending there is potential fraud in these organizations amounting to approximately $5 billion annually.

Many organizations have definitions of fraud that are understood by fraud investigators. For instance, the AICPA issues auditing standards that direct how audits should be conducted. From a fraud perspective, one of the more important standards issued by the AICPA is the statement of auditing standards 99 consideration of fraud in a financial statement audit. The AICPA describes fraud as follows:

“Fraud is a broad legal concept and auditors do not make legal determinations of whether fraud has occurred. Rather, the auditor’s interest relates to acts that result in a material misstatement of the financial statements. The primary factor that distinguishes fraud from error is whether the underlying action that results in a misstatement of the financial statements is intentional or unintentional. For purposes of the statement, fraud is an intentional act that results in a material misstatement in financial statements that are subject of an audit.”

The key points to understand from AICPA’s definition are:

• Fraud determinations are legal in nature.
• Fraud is an intentional action conducted by someone in the organization.

In addition, AICPA points out that while auditors provide information to support fraud allegations they do not make legal determinations of fraud. The AICPA also discusses the concept of professional skepticism where auditors should assume that fraud exists and conduct a brainstorming exercise concerning potential fraud schemes as they plan how to conduct specific audits.

We can find some very interesting information by examining the details of the ACFE fraud study. The ACFE asked a group of certified fraud examiners to report on fraud through an online survey instrument. A fraud report is produced based on the responses reviewing specific cases.  A total of 1,388 fraud cases were incorporated into the fraud study. The results for the United States included 788 fraud cases and 141 cases were reviewed for public service organizations.

In ACFE’s study, occupational fraud is defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misappropriation of the employing organization’s resources or assets.” In developing the fraud profile for specific organizations, ACFE uses a three-part fraud scheme definition that includes asset misappropriation, corruption and financial statement fraud.

Asset misappropriation schemes occur when an employee steals or misuses the organization’s resources. Examples of this include theft of cash, false billing or inflated expense reports. Corruption schemes occur when an employee misuses his or her influence in a business transaction in a way that violates his or her duty to the employer in order to gain a direct or indirect benefit, such as schemes involving bribery or conflicts of interest with vendors. The third category of fraud is financial statement fraud schemes defined as an employee intentionally causing a misstatement or omission of material information in the organization’s financial reports, including the recording of fictitious revenues, understating reported expenses or artificially inflating reported assets.

The ACFE provides useful information as to how fraud is detected in organizations. The largest way that fraud is detected in public service organizations is by tips from employees and others. Approximately 53 percent of fraud cases are identified through tips. Management reviews found 15 percent of the fraud cases, while internal audits uncovered 14 percent of the cases. These statistics show that anti-fraud tools such as an employee hotline are the most effective tool in identifying fraud.

The ACFE study examined numerous fraud cases that occurred in the United States. The largest amounts of fraud cases were related to corruption, cash thefts, false billing claims, payroll and other false expense schemes. The study also provided useful information concerning where fraud occurs in an organization. The accounting department had the largest amount of fraud cases. Significant amount of fraud also occurred in the following departments:

• Operations
• Sales
•  Executive and upper management

The ACFE fraud study is useful since it showed that the place to look for fraud in public service organizations includes the accounting department and those departments related to executive management, operations and sales. The best way to identify fraud is through tips from employees and others. It is noteworthy that traditional managerial reviews, such as internal audits, do not find that much fraud. The types of fraud that are most often used relate to cash theft schemes, false billing and expense claims and payroll schemes.

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