Internal fraud investigations arise when fraud is suspected within an

organization. Investigators conduct procedures that far exceed the scope of a

customary audit. In fact, they are responsible for developing evidence to
support a case that has the potential to be successfully prosecuted.

The first part of this series presents the terminology essential to developing expertise in fraud
investigative techniques. In addition, an overview of civil and criminal law and proceedings is
offered. Successful prosecution of white-collar crime (i.e., internal fraud) depends heavily on
following strict rules of evidence collection to protect the rights of all parties involved.

The process of investigation also is known as fraud examination. However, this paper uses
investigation to refer to the process of collecting and presenting evidence in a fraud case. The person
responsible for the process is called an investigator.

Internal Fraud Investigation Basics

Fraud investigation is a methodology of resolving fraud allegations from inception to disposition.
More specifically, fraud investigation involves:

 Obtaining evidence and taking statements.

 Writing reports.
 Testifying to findings.
 Assisting in the detection and prevention of fraud.

Initiating a Fraud Investigation

Frauds are discovered by any of several sources, including tips or complaints from someone,
auditing procedures, or by luck. No matter how the initial indicator comes to light, the
accumulation of the evidence to prove or disprove the allegation of fraud is substantially different
from a routine audit. It is necessary to have counsel involved in, and in most cases, "directing"
the investigation, at least as far as the legal aspects of the case are concerned.

Evaluating Tips
One formal study showed that about one-third of all internal investigations begin with a tip from
a co-worker, manager, or other employee. Audits, on the other hand, uncover about 20 percent
of internal thefts, while the remainder is discovered by "accident."

Companies should encourage a reporting system that allows anonymous tips to be furnished to
security, audit, or management. Because most tips are not actually valid, it is important to

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understand the motives of persons willing to supply information to evaluate whether the tip
merits further inquiry. The three principal reasons, explored below, that persons furnish tips are:

1. Revenge.
2. Genuine concern.
3. Money.

Revenge
Co-workers furnish information as a result of some grudge against a fellow employee to cause
trouble. This information often is without value, and careful screening of the information can
eliminate the need for an unnecessary investigation.

Genuine Concern
In some instances, the tipster does indeed find information of value worthy of initiating an
internal fraud case. The tipster observes some activity that is suspicious and feels a sense of
obligation to report it.

Money
Some persons will furnish information in response to an offer of financial reward. Although these
situations may result in valuable information, in still other cases the information is fabricated for
the purpose of obtaining money. Investigators should be circumspect in paying for information.

Investigation Methodology
Regardless of the nature of the fraud investigation, three basic tools are available to the
investigator:

 Interviewing.
 Document examination.
 Observation.

Interviewing
Interviewing consists of the process of obtaining relevant information about the matter from
those with knowledge.

Document Examination
The investigator must be skilled in the examination of financial statements, including journals,
ledgers, and supporting documents. He or she must also know the legal ramifications of evidence
and how to maintain the chain of custody over documents.

Observation
The investigator often is in a position to observe behavior, to search for obvious displays of
wealth, and in some instances is able to observe specific offenses.

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Steps in Fraud Investigation
Fraud investigation steps are constructed so that all cases are handled in a uniform fashion. The
methodology involves going from the general to the specific, beginning with the examination of
documents. The five steps, discussed below, are:

1. Document examination.
2. Neutral third party witnesses.
3. Corroborative witnesses.
4. Co-conspirators.
5. Accused.

Document Examination
As a general rule, documents should be examined before interviews are conducted to gain an
understanding of the potential evidentiary value of the case and to protect the security of
documents.

Neutral Third-Party Witnesses

After conducting sufficient document examination, witnesses should be interviewed in a logical
fashion starting with the least likely to the most likely to be involved.

Corroborative Witnesses
Interviews from witnesses to corroborate facts should be conducted after the neutral third-party
witnesses. Note that these witnesses may or may not be cooperative.

Co-Conspirators
Those suspected of complicity should be interviewed next, from the least culpable to the most
culpable. If appropriate, law enforcement officials and prosecutors can promise leniency in return
for cooperation.

Accused
In general, the accused is examined last. Even if the accused is not likely to offer a confession,
an interview is usually scheduled because in many instances it can be used for subsequent
impeachment.

Internal Fraud and the Law

Investigators should be knowledgeable of the meaning of terms commonly used during fraud

investigations. The definitions provided in this section are taken from Black's Law Dictionary .

Definitions:

Fraud
All multifarious means which human ingenuity can devise, and which are resorted to by one
individual to get advantage over another by false suggestions or suppression of the truth, and

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includes all surprise, trick, cunning, or dissembling, and any unfair way by which another is
cheated.

Embezzlement
Willfully to take, or convert to one's own use, another's money or property, of which the
wrongdoer acquired possession lawfully, by reason of employment or position of trust.

Larceny
Felonious stealing, taking and carrying, leading, riding, or driving away another's personal
property, with intent to convert it or to deprive owner thereof. The unlawful taking and carrying
away of property of another with intent to appropriate it to use inconsistent with latter's rights.

Corruption
An act done with intent to give some advantage inconsistent with official duty and the rights of
others. The act of an official or fiduciary person who unlawfully and wrongfully uses his (her)
station or character to procure some benefit for himself or for another person, contrary to duty
and the rights of others.

Bribery
Giving or receiving (or offering or soliciting) any thing of value to influence an official act.

Illegal Gratuity
Giving or receiving (or offering or soliciting) anything of value for or because of an official act.

Economic Extortion
A demand of payment by the recipient to refrain from discriminating against a business decision.

Conflict of Interest
An agent taking an interest in a transaction which is actually or potentially adverse to the interest
of the principal without disclosure to the principal.

Elements of Fraud
There are four general elements under common law, which all must be present for a fraud to
exist:

1. Misrepresentation of a material fact.

2. Made knowingly and with intent to defraud.
3. Reliance on the misrepresentation by the victim.
4. Resulting in injury from such reliance.

Ways to Prove a Suspect's Intent to Defraud

 Alteration of documents.
 Concealment of evidence.
 Destruction of evidence.
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  False statements (lies).
 Personal gain.
 Obstruction of justice.
 Pattern of conduct (repetition of behavior).
 Testimony of co-conspirator.
 Admissions.
 Confessions.

Evidence of Fraud
Evidence consists of anything perceivable by the five senses and any proof, such as testimony of
witnesses, records, documents, facts, data, or tangible objects, legally presented at a trial to
prove a contention and induce a belief in the minds of a jury. Evidence may be direct or indirect:

Direct Evidence proves the fact directly. Eyewitness identification or a confession is an example of
direct evidence.

Circumstantial Evidence proves the desired fact indirectly, and its value depends on the strength
of inferences raised by the evidence.

Admissibility of Evidence
To be admissible, evidence must be both relevant and material. Evidence is relevant if it tends to
make some fact in issue more or less likely. Some of the items considered relevant include:

Motive for an offense.

Ability of defendant to commit the offense.
Opportunity.
Threats or expressions of ill will.
Means of committing the offense.
Physical evidence linking the suspect.
Attempts to conceal or destroy evidence.

Evidence may be relevant but still excluded if the evidence:

 Is unduly prejudicial.
 May confuse the jury.
 Is cumulative of other evidence.
 Is privileged.

Exclusionary Rule refers to evidence obtained illegally or improperly, which may also be excluded.

Materiality Rule refers to the fact that evidence must be relevant to an issue in the case or assist
in proving a point. Repetitive or additive evidence usually is excluded.

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Judicial Notice is the process by which the judge may, on his or her own motion and without
production of evidence, recognize certain indisputable facts that bear on the case.

Evidence of Other "Bad" Acts. Evidence that the defendant committed other crimes, wrongs, or
acts may be used to prove intent, absence of mistake, common scheme or plan, or other
elements of the offense. Such evidence may not be introduced merely to prove bad character.

Comparison of Civil and Criminal Fraud

The investigator should be aware of some key differences between civil and criminal fraud to
ensure that proper procedures for developing a prosecutable case are followed.

Basic Premises
Intent
Wrongful intent or "guilty knowledge" normally must be proven in civil and criminal fraud cases.
In civil litigation for breach of fiduciary duty, intent or knowledge does not have to be proven.

Burden of Proof
In criminal cases, the burden of proof is beyond a reasonable doubt; juries must rule
unanimously on guilt. In civil litigation, the standard of proof is much lower, and may be decided
by merely a "preponderance" of evidence. The verdict does not necessarily have to be
unanimous. Nature of Acts
A crime is a public wrong, punishable by deprivation of life, liberty, or property in a criminal
prosecution.

A tort is a private wrong, such as fraud, punishable by deprivation of property in a civil action for
damages.

Parallel Proceedings
A civil fraud case may proceed at the same time as a criminal prosecution, but the prosecution
may not use discovery in a criminal case solely to build a civil claim. Evidence collected in a
legitimate criminal investigation may, however, be used in a civil case if proper disclosure
procedures are followed.

Civil Actions
A victim of fraud may bring a civil action for actual and punitive damages. Most civil actions are
based on the "common law" right to recover losses for fraud, but also may be based on state or
federal statutes, which can provide for treble damages.

Civil procedures must be followed when a civil case is to be prosecuted:

Complaint or petition filed and answered.

 Discovery.
 Trial.
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  Judgment.

Complaint or Petition Filed and Answered

Civil actions begin with the filing of a complaint or a petition that is a short statement alleging the
facts establishing liability. Complaints in fraud cases must allege the fraud with particularity.
Defendant usually will file an answer, counterclaim, or procedural motions.

Discovery
Discovery is the formal evidence collection process that starts after the case has been filed. The
principal means of discovery are oral depositions, written interrogatories and requests for the
production of documents.

Trial
Civil trials are similar to criminal cases, but with exceptions:

 Juries do not need to consist of 12 persons.

 Various claims may be joined in one action.

Judgment
 Parties may stipulate to a less than unanimous verdict.
 Verdict is for money damages.

Criminal Actions
Criminal Actions are characterized by the following rights granted the suspect:
 Presumption of innocence.
 Right to remain silent (Miranda warnings).
 Right to confront accusers.
 Right to counsel.
 Speedy trial by jury of peers.
 Consensual searches.

Miranda Warnings
 The right to remain silent.
 Any statements made can be used against the suspect.
 The suspect has the right to an attorney.
 An attorney will be appointed if the suspect cannot afford one.

Criminal Procedures Elements of a criminal fraud case include:

 Indictment and information.
 Arraignment.
 Pre-trial procedures.
 Trial process.

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Indictment and Information
All capital and felony offenses under the federal system must proceed under an indictment. If the
defendant waives the right to indictment, he or she may be charged on an information, which is
signed by the prosecutor.

Arraignment
After a defendant is indicted, he or she is brought before the court for an arraignment, at which
time the charges are read in open court. The defendant may plead guilty, not guilty, or nolo
contendere (does not contest the charges, but does not admit or deny them). If the defendant
pleads guilty or nolo, he or she is bound over for sentencing. If not, the defendant is bound over
for trial.

Pre-Trial Procedures
The defendant, through counsel, may move to have the indictment dismissed, evidence
suppressed, co-defendants severed (granted separate trials), or for other relief. The defense is
also entitled to limited discovery of the prosecution's case. The identity and statements taken
from the government's witnesses may be withheld until after the witness testifies.

Trial Process
The trial process consists of three stages:

 Jury selection.
 Trial stages.
 Appeal.

Prosecution Policies
Many prosecutors shy away from white-collar cases due to their own lack of experience or
interest. They may refuse a case because of a heavy caseload. Who the case is presented to
often is more important than how the case is presented.

If possible, present the case to a lawyer or prosecutor who has:

 A successful track record in white-collar cases.

 A reputation as a hard worker.

Contact the lawyer as early as possible to get advice regarding:

 Which legal elements need to be proven.
 What type of evidence may be required.
 Assistance in negotiating with reluctant witnesses.
 The availability of grand jury subpoenas and related items.