Corporate Governance Structure: Prevention Environment

PREVENTION ENVIRONMENT
A key to successful fraud prevention is to look at the entity’s culture and

try to change it, if necessary. Some activities and attitudes can help in
achieving this goal. The important prevention elements that are discussed
next are generally applied to an entity, and not necessarily directed toward a
specific fraud.
Corporate Governance Structure
Prior to the passage of SOX, research had shown that weak corporate
governance was associated with all of the major financial frauds. For instance,
the COSO Landmark Study (1998) studied 200 of the 300 fraud cases handled
by the Securities and Exchange Commission (SEC) from 1987 to 1997.1 The
researchers found a distinctive pattern of weak boards for those entities
investigated. Seventy-two percent of the cases identified the chief executive
officer (CEO), and 43 percent named the chief financial officer (CFO) as being
involved with the fraud. In addition, according to Wheel, Deal and Steal, the vast
majority of the boards are chaired by a former or current CEO.2
Weaknesses from the report were summarized as follows:
n Board members who were not independent
n Board dominated by insiders
n Board members with significant equity holdings
n Board members with little board experience
n Boards and audit committees that did not meet
n Audit committee members who knew little about finances or auditing
n No audit committee
n Audit committee did not meet
n Top executives involved in the frauds
To have an effective antifraud culture, an entity should have policies and

procedures that:
n Define frauds
n Describe publication and communication of policy
n Describe implementation of controls for antifraud
n Describe training
n Describe proactive fraud audit measures
n Describe testing of antifraud controls
n Define investigation policies and procedures
n Describe actions taken in fraud audit
n Describe the analysis of evidence
n Describe resolutions to frauds
n Describe incident reporting procedures
PERCEPTION OF DETECTION
Antifraud professionals agree that perception of detection is at the top of the list
of fraud prevention measures. In fact, based on years of law enforcement and
criminal justice experience, crime experts say the best deterrent to crime,
including fraud, is the perception of detection. Because white-collar criminals
who commit fraud tend to have some personal code of ethics, this technique is
even more effective in preventing fraud than it is for ‘‘street’’ crimes. The fear of
jail, humiliation, or loss of family ties is enough of a deterrent for many potential
fraudsters to cause them to stop, think, and decide it is not worth the total cost.
The best thing any entity can do to minimize fraud is to find a cost-beneficial
way to increase the perception of detection. Some ways to increase the
perception of detection include:
n Surveillance
n Anonymous tips
n Surprise audits
n Prosecution
n Enforcement of ethics and fraud policies
n Catch me if you can!
Surprise Audits
Internal audit is the highest-ranked proactive method of detection (per the
Association of Certified Fraud Examiners [ACFE] Report to the Nation [RTTN]
statistics). But surprise audits by either the internal audit function or hired fraud
auditors are evenmore effective. Not only can these audits serve a similar purpose
in detecting frauds (which can then be considered for further preventive measures),
but the fact the surprise auditwas unannounced can create a perception of
detection. Fraudsters do not know when the fraud auditor is going to showup, so
they cannot prepare to fool the auditor. In fact, in at least one fraud, a fake
announcement of a surprise audit (the internal auditor was attempting to play a
joke) caused the manager of the business unit to confess to a fraud.
ACCOUNTING CYCLES
One way to address prevention measures is to examine the accounting business
processes in their natural cycles. Considering some of the common characteristics
of frauds in these areas is a way to develop effective prevention measures
therein. Here we present a few examples to illustrate preventive measures that
might be affected.
SUMMARY
It is obviously more desirable to prevent fraud than to detect it after it occurs.
There are a limited number of prevention methods (e.g., perception of detection)
an entity can employ, but they are essential to a fraud-free environment.
There are environmental issues that can enhance those preventive methods. A
careful analysis of the business processes in the accounting cycle provides
valuable input into preventive measures. Together, the countermeasures and
concepts herein should enable auditors to assist management in developing an
effective antifraud program that can minimize frauds.

Corporate Governance Structure: Prevention Environment

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PREVENTION ENVIRONMENT

A key to successful fraud prevention is to look at the entity’s culture and

n Board dominated by insiders

n Board members with significant equity holdings

n Board members with little board experience

n Boards and audit committees that did not meet

n Audit committee members who knew little about finances or auditing

n Audit committee did not meet

n Top executives involved in the frauds

To have an effective antifraud culture, an entity should have policies and

n Describe publication and communication of policy

n Describe implementation of controls for antifraud

n Describe proactive fraud audit measures

n Describe testing of antifraud controls

n Define investigation policies and procedures

n Describe actions taken in fraud audit

n Describe the analysis of evidence

n Describe resolutions to frauds

n Describe incident reporting procedures

n Enforcement of ethics and fraud policies

n Catch me if you can!

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