INTERNAL AUDITS ROLE IN PREVENTING FRAUD

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Recent changes in legislative and regulatory requirements along with the rising cost of fraud have led to an increased concern over fraud management practices.

While many Internal Audit functions seek to implement effective antifraud measures, they face an array of fraud management methods offering varying degrees

of success. Therefore, it is critical that Internal Audit functions seek to implement the initiatives that have greatest ability to impact the organization at a

reasonable cost.

Constrained resources (including personnel, time, or budgetary constraints), drive Internal Audit to carefully select on the most cost-effective methods. This

survey provides readers with a snapshot into insider trends in detecting, preventing, and investigating fraud.

KEY IDEAS

Sarbanes-Oxley May Not be Enough: Respondents remain concerned over the risk of financial statement fraud suggesting that recent legislation enacted to

minimize occurrences of such fraud may not be adequate.

IT Fraud Poses an Emerging Threat: The increased use of technology is causing companies to become more susceptible to fraud as demonstrated by the

fact that survey respondents ranked computer crime second highest as the type of fraud that concerns them most. The problem is exacerbated by the fact that

many internal audit departments do not possess the necessary IT audit skills to help protect the company against this significant threat.

The Fraud Risk Assessment Imperative: The number one fraud challenge for survey participants was providing the Audit Committee and External Auditor

with assurance that fraud is well managed across the organization. Implementing a comprehensive fraud risk assessment is the most effective way to

demonstrate to key constituents that fraud vulnerabilities have been identified and are well managed. Not surprisingly, implementing fraud risk assessments

was the number two challenge with establishing a fraud program for survey participants.

Creating a Culture of Fraud Awareness: Respondents reported that another significant fraud-related challenge is communicating fraud awareness across

the organization. Promoting awareness of fraud schemes and indicators provides management with the tools to address and identify fraud early resulting in improved controls and efficiency gains.

Moving Beyond a Compliance Focus: Survey participants responded that many of the required measures that companies are implementing to help prevent

fraud are not necessarily the most useful ones revealing a gap between current recommendations and end-state ideals. Companies need to move beyond

merely a compliance focus and implement measures that will result in true and effective fraud prevention and detection.

Audit Director Roundtable Survey Results Audit Director Roundtable Survey Results

Internal Audit's Role in Detecting, Preventing, and Investigating Fraud Page 2

OVERVIEW OF PARTICIPATING MEMBERS

Responses to the Roundtable survey were collected from 44 institutions across the membership, representing 15 industries from various revenue bands. As

respondents are self-selected, this data cannot be considered the result of a scientific poll; nonetheless, they serve as a useful benchmarking guide for Roundtable

members. An overview of the survey participants are provided below:

Survey Participants by Revenue

Survey Participants by Industry

($ in Billions)

Insurance

19%

Banking

2%

Between 3 and 10

28%Between 1 and 3

28%

Less than 1

7%

M ore than 25

7%

Between 10 and 25

30%

Business Services

2%

Chemicals

5%

Computer Software

2%

Electronics

2%

Energy & Utilities

9%

Utilities

7%

Consumer Products

Financial Services

16%

Health Care

2%

Food

5%

Telecom

9%

Construction

2%

Transportation

14%

Unknown

2%

2%

TOP OF INTERNAL AUDIT'S FRAUD CONCERNS

Participants were asked to rank the following five types of fraud on a scale of 1 to 5, where 1 = not worried at all, and 5 = worried a lot. Interestingly,

respondents significantly more concerned about asset misappropriation than financial statement fraud despite the fact that asset misappropriation schemes have a

far smaller median loss ($93,000) than fraudulent statement schemes ($1,000,000)1. Respondents are likely most concerned about asset misappropriation because

these types of schemes occur most often in business. However, the fact that financial statement fraud still ranked so highly as a worry suggests that there is still

work to be done beyond the recommendations of Sarbanes-Oxley to manage this threat.

Survey results indicate that computer crime remains a significant concern. This concern implies that technological advances are increasing the risk and opening

doors to more forms of fraud or easing the ability of perpetrators to commit fraudulent acts.

Corruption and bribery was marked highest by respondents in the financial services, transportation, telecommunications, and energy and utilities industries.

Organized crime was also ranked highest by members in the financial services, telecommunications and transportation industries as these industries may be more

prone to such activity.

RANKING THE AMOUNT OF CONCERN ASSOCIATED BY TYPE OF FRAUD

Misappropriation of Assets

Computer Crime

Financial Statement Fraud

Corruption/Bribery

Organized Crime

3.3

3.2

2.6

1.8

3.5

Internal Audit worries

markedly more about the

misappropriating of assets,

computer crime, and financial

statement fraud than

corruption or organized crime

n = 44 Source: Audit Director Roundtable Research

MOST CHALLENGING ELEMENTS OF FRAUD

Members indicated that the most challenging element of establishing a fraud program is providing assurance to the external auditor and the Audit Committee that

fraud is being effectively managed. It follows that members are also struggling with implementing a fraud risk assessment as this tool may be an effective way to

demonstrate to the Audit Committee or the External Auditor that the company has identified and implemented a concerted effort to manage fraud across the

organization.

Respondents also reported challenges with continuously monitor fraud in a cost effective manner. They are also struggling with communicating fraud awareness

across the company as more often than not, business unit management is not aware of the magnitude or impact of fraud and is not well-versed in fraud schemes,

scenarios, red flags or mitigating controls. In follow-up interviews, respondents indicated that providing line management with the tools and knowledge to better

manage fraud on the front lines will go a long way to reducing the threat of fraud and dollar loss associated with it.

DIFFICULTY IN ESTABLISHING A FRAUD PROGRAM

Understanding what fraud efforts are enough to provide AC and EA with

assurance that fraud is effectively managed

Understanding how to implement fraud risk assessment

Understanding how to continuously monitor fraud

Understanding how to communicate fraud awareness companywide

Understanding how fraud risk assessment and mitigation most efficiently fit into

current audit activities

Understanding how to train audit staff to better detect fraud

Understanding how IA may be more proactive in fraud mitigation

Understanding how IA may reduce the risk of financial reporting

Understanding IA's role in developing a fraud program

n = 44

7%

20%

25%

28%

32%

35%

39%

48%

61%

70%

68%

66%

65%

64%

56%

61%

48%

34%

23%

11%

9%

7%

9%

5%

5%

5%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Most Challenging Somew hat Challenging Not Challenging

Source: Audit Director Roundtable Research

. 2004 Corporate Executive Board

Audit Director Roundtable Survey Results Audit Director Roundtable Survey Results

Internal Audit's Role in Detecting, Preventing, and Investigating Fraud Page 5

ROLE OF INTERNAL AUDIT AND MANAGEMENT IN FRAUD

Survey respondents were asked to rate (on a scale of 1 to 5) their perception of Internal Audit's and management's involvement and expertise in fraud prevention,

detection, investigation, reporting and training. According to our respondents, Internal Audit and management vary in the level of involvement and expertise in

fraud related activities. Surprisingly, internal audit sees themselves more involved in all aspects of fraud except prevention and awareness.

EXPERTISE IN FRAUD ACTIVITIES

2.6 2.9

Prevention

2.3 3.0

Detection

2.1 3.0

Investigation

2.5 3.1

Reporting

2.2 2.6

Awareness/Training

Audit Director Roundtable Survey Results Audit Director Roundtable Survey Results

Internal Audit's Role in Detecting, Preventing, and Investigating Fraud Page 6

ANTIFRAUD METHODS USED TO PREVENT/DETECT

Survey participants were asked to rate the degree of utilization and usefulness of various antifraud measures. Unsurprisingly, code of ethics, whistleblower

hotlines and internal controls ranked to the top in terms of utilization due to the fact that they are mandated by law. Of note, select measures that did not get high

marks in terms of utilization (fraud awareness training, fraud risk assessments, fraud auditing), did receive high marks for usefulnessgiving weight to the fact

that companies should embrace the spirit of the law rather than the letter of the law when it comes to choosing where to allocate antifraud resources.

ANTI-FRAUD METHODS

UTILIZATION OF METHODS

86%

75

91%

%

68%

64%

50%

49%

48%

47%

44%

43%

41%

40%

30%

Code of Ethics

95%

100%

Whistleblower Hotline

93%

Internal Control Review

Periodic Compliance Audits

Conducting Background Checks for Hires

with Budget Responsibility

Fraud Reporting Policy

Ethics Training

Appointing Compliance Personnel

External Audit Detection of Fraud

Fraud Prevention/Detection Training

Conducting a Fraud Risk Assessment

Continuous Monitoring of Key Fraud Risks

Fraud Auditing

Anonymously communicating out actual

Instances of Fraud to the Organization

Staff Rotation

Employee Contracts

Forensic Accounting

100%

0%

USEFULNESS OF METHODS

9% 20%

3% 28%

12% 30%

18% 30%

18% 32%

24% 30%

18% 22%

6% 38%

3% 30%

27% 28%

27% 40%

24% 44%

30% 50%

24% 58%

18% 68%

48% 50%

39% 58%

0% 20% 40% 60% 80% 100%

Very effective

Somewhat effective

Not effective at all

1%

6%

2%

2%

1%

1%

11%

6%

2%

5%

2%

2%

1%

1%

1%

While external audit detection of fraud was used by half of the survey

participants, it scored the smallest in terms of very effective (7%) and largest in

terms of not effective at all (25%).

Source: Audit Director Roundtable Research

n = 44

. 2004 Corporate Executive Board

PROFESSIONAL SERVICES NOTE

The Audit Director Roundtable has worked to ensure the accuracy of the information it provides to its members. This

project relies upon data obtained from many sources, however, and the Audit Director Roundtable cannot guarantee the

accuracy of the information or its analysis in all cases. Further, the Audit Director Roundtable is not engaged in rendering

legal, accounting or other professional services. Its projects should not be construed as professional advice on any particular

set of facts or circumstances. Members requiring such services are advised to consult an appropriate professional. Neither

Corporate Executive Board nor its programs is responsible for any claims or losses that may arise from any errors or

omissions in their reports, whether caused by Corporate Executive Board or its sources.

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