A Look Ahead: Supply Chain Forensics

IIA Chicago Chapter 53rd Annual Seminar April 15, 2013, Donald E. Stephens Convention Center @IIAChicago #IIACHI A Look Ahead: Supply Chain Forensics...
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IIA Chicago Chapter 53rd Annual Seminar April 15, 2013, Donald E. Stephens Convention Center @IIAChicago #IIACHI

A Look Ahead: Supply Chain Forensics Combine Data Mining and Forensic Accounting to Combat Financial & Fraud Risks within Supply Chains Clarke Warren Director Forensic Investigations Johnson Controls Mark Pearson Senior Manager, Deloitte Forensics Deloitte Financial Advisory Services

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Agenda – Supply Chain Forensics I.

The Issue

II.

Common Supply Chain Risks and Typical Overspend

III.

Use Supply Chain Forensics to Save Money and Reduce Risk

IV.

Data Mining Component

V.

Forensic Accounting Component

VI.

Conclusion

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The Issue

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The Issue

Persistent pressure upon companies to do more with less - Management must produce increasing profits and return on assets.

To achieve results, organizations increasingly rely upon business partnerships, which have become progressively more complex.

The complexity of this reliance can mask a myriad of financial, regulatory and legal risks.

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News Headlines

Alibaba Executives Resign on Supplier Fraud Scandal

Navy Setting up Contract Fraud Investigation Unit

China e-commerce giant Alibaba announced the departure of two executives after probe showed 2,326 suppliers defrauded online customers. 22 February 2011 Caixin Online, accessed October 12, 2011. April 15, 2013

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Common Supply Chain Fraud Risks & Typical Overspend

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Common Supply Chain Risks Lost Revenues

Underreporting of revenue tied to royalties Missed Cost Savings Vendor overcharges

Damaged Business Relationship Over time, a small difference in interpretation can have large impact Litigation Reactive alternative that can be very costly and damaging to reputation

Regulatory Inquiries Supply Chain details may impact financial reporting Reputational Risks Transacting business with unsavory entities or people April 15, 2013

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Typical Overspend – High Risk Spend Categories Labor Overtime rate versus straight-time rate Labor charged for people not on payroll (ghost employees) Rates charged are higher than contractually agreed rates Allocated or Shared Expenses Facility overhead allocation (or any other allocated expenses) Shared advertising or marketing costs

Cost Plus Transactions Vendor is incentivized to go with highest cost provider Third Party Passthrough's 3rd party pass-through expenses may in fact be for related-party

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Case Study – Supply Chain Fraud: Excerpt from vendor invoice #1095

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Case Study – e-Discovery and Computer Forensics Fragments of e-mail messages recovered via computer forensics: From: IT Director To: Wife Subject: RE:

From: Wife To: IT Director Subject: RE:

ok, XYZ, Co. [employer] is digging deeper im worried ----------------------------From: Wife To: IT Director Subject: RE:

Al can handle it — he's good -----------------------------From: IT Director To: Wife Subject: RE:

how do you know — they call you? ----------------------------From: IT Director To: Wife Subject: RE:

They‘re asking for a lot of detail - be praying

No called Al for more stuff April 15, 2013

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Case Study – ―Smoking gun‖ document recovered

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Photo of recovered document detailing the 3-way split of the payment of invoice #1095 1 — IT Director 2 — Bank Computer Leasing Mgr. 3 — Crooked Vendor 1 2 3

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Use Supply Chain Forensics to Save Money and Reduce Risk

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Supply Chain Forensics Goals

Identify & Recover Overpayments

• Identify fraud risks &

areas to recover potential overpayments or underpayments • Identify procedural

inconsistencies that could help the company strengthen processes

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Negotiate Terms of Future Agreements

• Revise agreements

by identifying and eliminating accounting loopholes • Identify payments

that company is not obligated to make

Control Supply Chain Performance Criteria and Evaluation

• Perform due

diligence on vendor track record • Identify relationships

between vendors and possible related entities

• Include the ‗right to

audit‘ in future agreements

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Supply Chain Forensics Process

Step 1

Due Diligence & Risk Analysis

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Step 2

Data Mining

Step 3

Step 4

Forensic Accounting

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Control & Remediation

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Due Diligence – Visual Relationship Mapping

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Risk Analysis – Supply Chain Fraud Risk Matrix

Employee only

Employee & External Party

External Party i.e. Supplier/ Distributor Competitor

Procurement

Inventory

Production

Distribution

• • • • •

Phantom vendors False invoices Invoice mark-up / alteration Redirection of delivery Theft of intellectual property

• Theft of inventory • Fraudulent or improper inventory capitalization • Manipulation of inventory accounting / inventory counts / quantity (fictitious inventory) • Falsified documents (shipping documents, sales orders, receiving report)

• Theft of intellectual property • Inaccurate / falsified forecast of raw materials, spare parts or finished goods • Theft of raw materials, finished goods or scrap • Sales of backdoor goods • Redirection of business to an undisclosed related party • Personal use of inventory or assets

• • • •

• • • • • • • • •

Bribery / kickbacks Conflict of interest Collusion in bidding Unnecessary / excess orders Duplicate ordering Duplicate payments Order splitting Exclusion of qualified vendors Theft of intellectual property

• Bribes from subcontractor • Invoices for goods not received • Inventory write off (lost, obsolete, scrap) • Corporate espionage

• Kickbacks / bribes may lead to bias in selection of suppliers / vendors, inflate forecasts of raw materials or finished goods requirements or sabotage production (also known as industrial espionage) • Theft of intellectual property • Bribery of government employees

• • • • • •

• Bribery of subcontractors • Inflated or fictitious invoices • Short shipments or substitution of lower quality goods • Invoices for goods not received

• Unqualified consultants • Misrepresentation of technical capability and / or capacity by suppliers / vendors

• Distribution of counterfeit products by competitors • Bribery of customers by competitors • Theft of finished goods • Reseller / distributor misrepresenting technical, financial or ethical position • Sabotage of finished goods

• Bribery of third party • Improper government relationship • False or misstated invoices • Overstatement of business experience • Suppliers misrepresenting their financial, technical or ethical position

Theft of finished goods Mark up transport costs Falsified distribution records Grey market distribution

Collusion with transporters Channel stuffing Theft of intellectual property Theft of finished goods Sales of backdoor goods Collusion with distributor / reseller • Grey market distribution

Source: ―Procurement Integrity Risk Matrix‖, Fraud Risks in the Supply Chain, 2010. Deloitte and Touche Financial Advisory Services Ltd

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Case Study – Processing through shared services Summary of checks paid for false purchase orders

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Case Study – Processing through shared services

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Case Study – Processing through shared services

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Case Study – Processing through shared services

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Case Study – Bypassing vendor add process

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Data Mining Component of Supply Chain Forensics

Data Mining Component of Supply Chain Forensics

Step 1

Due Diligence & Risk Analysis

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Step 2

Data Mining

Step 3

Step 4

Forensic Accounting

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Control & Remediation

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Supply Chain Forensics - Data Mining Approach

1. Select Supply Chain and Obtain Data 1.

Select vendors for review

2.

Obtain electronic data – e.g. invoices, contract data

3.

Review data to confirm validity, accuracy & completeness

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2. Transform and Analyze Data

1.

Transform and load data into the analytics database

2.

Reconcile line items against A/P

3.

Identify gaps

3. Conduct Testing

1.

2.

Execute analytics review queries (incorrect labor rates, excess hours, duplicate charges, invalid expenses)

4. Report Claims

1.

Validate observations

2.

Transition data to forensic accountants

Create custom queries (unique contracted terms, key word searches)

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Supply Chain Forensics - Typical Data Required 1. Select Supply Chain and Obtain Data

2. Transform and Analyze Data

3. Conduct Testing

4. Report Claims

Common to All Invoices Labor Invoice Detail Equipment/Consumables Invoice Detail Worker Expense Detail Personnel File Payroll Records Agreements Financial Additional Information April 15, 2013

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Common Database Library

Agreements • Rates and Terms

Invoice Support •Line item details

Ancillary • Personnel and Assets

Financial • AP, Invoices and Credits

Data Flow

Transform and Analyze Data

Reconcile

CDL

Normalize

Conduct Testing - Execute Queries (canned and custom)

Report Claims

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Conduct Testing - Types of Analytical Queries 1. Select Supply Chain and Obtain Data

2. Transform and Analyze Data

3. Conduct Testing

4. Report Claims

Common data mining analytical queries are listed below: Labor • Duplicate labor charges • Incorrect labor rate charges • Position changes • Excess overtime charged • Reasonable hours charged • Ghost Employees charged • Labor charged after termination or before hire • Incorrect Consultant charges Equipment • Incorrect equipment rate charges • Duplicate equipment charges • Equipment invoiced versus Fixed Asset Register April 15, 2013

Invoice • Duplicate invoices • Duplicate 3rd party invoices Consumables • Duplicate material charges • Incorrect material rate charges Labor Expenses • Duplicate out of pocket expense • Invalid Per Diem charges Subcontractor • Duplicate subcontractor charges • Incorrect mark up

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Forensic Accounting Component of Supply Chain Forensics

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Supply Chain Forensic Accounting Component

Step 1

Due Diligence & Risk Analysis

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Step 2

Data Mining & Analytics

Step 3

Step 4

Forensic Accounting

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Control & Remediation

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Forensic Accounting Approach

Step 5 Step 4

Step 3 Step 2

Step 1

• Define Population & Determine Sample

• Vet findings with Vendor

• Extrapolate Sample Results

• Forensic Accounting Procedures

• Vendor Interviews April 15, 2013

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Supply Chain Forensics – Forensic Accounting Approach 1. Forensic Interviews & Risk Analysis 1.

Select vendors for review

2.

Obtain background information on vendor

3.

4.

Interview vendor personnel to broaden intelligence about processes & transactions Develop riskranking of transaction types & characteristics

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2. Choose Transactions to Test 1.

2.

3.

3. Conduct Testing

Combine transaction riskranking with all available information to create populations

1.

Provide input to forensic data mining query structure

2.

Determine sample of transactions for testing

3.

Vet query results to supporting documentation (fixed asset registers, payroll reports, etc.)

Ensure transactions show: 1. Authorization 2. Existence 3. Approval Manually test nonqueriable transactions (subcontractor rates tie to agreement?)

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4. Report Claims

1.

Validate observations with vendor

2.

Bifurcate findings into those that have a chance of recovery, and those that are process-oriented.

3.

Work with legal counsel and vendor to reach mutually agreeable settlement of findings.

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Supply Chain Forensics – Forensic Example

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Control & Remediation Component

Step 1

Due Diligence & Risk Analysis

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Step 2

Data Analytics

Step 3

Step 4

Forensic Accounting

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Supply Chain Litigation & Dispute Resolution

Most Supply Chain Forensic examinations can be dealt with in a mutually agreeable manner. However, litigation & dispute resolution can help in cases where commercial settlement becomes necessary. Litigation & Dispute resolution helps counsel with challenging financial and economic issues in complex litigation and other business disputes relating to supply chain fraud. Utilize tools, methodologies and technology that include data mining and mapping, electronic discovery and computer forensic capabilities.

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Conclusion - Supply Chain Forensics

Due Diligence & Risk Analysis

Data Mining

More efficient, Supply Chains, additional profits & reduced risk

Remediation Forensic Accounting

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