From Fraud to Recovery: The Essentials of Forensic Accounting

While fraud investigation is integral to any forensic accounting practice, it is more chaotic than some other accounting pursuits. For example, a practitioner may utilize established audit checklists and work programs to ensure that relevant factors are appropriately considered in more traditional financial statement audit engagements. Fraud investigations tend to be more fluid and less linear. At times, fraud investigations are initiated in response to a broad allegation that something is amiss. The path to ascertaining that a fraud has been perpetrated, the extent of the fraud, and the identification of culpable parties will likely include twists, turns, and even some dead ends.

Irrespective of the chaos accompanying a fraud investigation, certain factors must be addressed in any such engagement. Some of these factors are outlined below.

Role of Internal Controls

Generally, most successful frauds are partially attributable to some failure in an entity’s internal control environment. Sometimes referred to as “checks and balances,” an internal control system is intended to prevent, detect, and deter asset misappropriation by employees. However, as we often see, perpetrators are aware of the internal control deficiencies within the organization and exploit them to carry out and conceal their fraud. Most commonly, these are individuals who manage the finances, hold positions of authority, or oversee the financial controls.

The fraud within the federal “COVID” relief programs (i.e., the Paycheck Protection Program commonly referred to as “PPP”) illustrates the consequences of the failure to establish and maintain an effective internal control system. It has been widely reported that given the circumstances, government officials intentionally relaxed or disregarded existing internal controls, contributing to “… the largest fraud in U.S. history — the theft of hundreds of billions of dollars in taxpayer money intended to help those harmed by the coronavirus…”¹

A relaxed or nonexistent internal control environment also illustrates the “opportunity” component of the “fraud triangle” developed by Donald Cressey.

Cressey’s hypothesis (i.e., “fraud triangle”) evolved from his interviews of multiple persons convicted of embezzlement. Cressey’s interviews identified three factors that embezzlers shared: pressure, opportunity, and rationalization.

In addition to quantifying the loss, it is also our job to determine how the theft occurred, revealing the method(s) used by the perpetrator to commit and conceal the fraud. This examination can be helpful to organizations that experience employee theft as they undergo the imperative task of reevaluating their internal financial controls to avoid recurrence in the future.

Failure to maintain an effective internal control environment may also jeopardize the potential recovery of fraud losses, as certain fidelity bond insurance policies may require the insured to demonstrate that such an evaluation was performed before the employee theft. If an insured had lax controls or negligently disregarded their established controls, then their insurance carrier may deny the organization’s claim.

Referral to Law Enforcement

Organizations that fall victim to financial crimes often need to weigh the decision of whether to pursue criminal prosecution of the perpetrators. Factors to consider include the amount of the loss, the adequacy of non-criminal remedies, and potential negative publicity resulting from law enforcement referrals. However, again, organizations that are protected against employee theft through fidelity bond insurance coverage should be aware that such insurance policies may require referral to law enforcement to be able to collect on a claim. Organizations should consult with their insurance carrier and, if needed, engage a third party to assist with preparing claims submissions.

The Road to Fraud Recovery: Understanding Loss Reclamation in Financial Crimes

At some point in any fraud investigation, the focus will shift from the objective of documenting financial losses attributable to fraud to the more important goal of recovering the purloined assets. Victims are often more concerned with recovering their losses than pursuing criminal prosecution of the perpetrator.

Unfortunately, recovery may be more difficult than envisioned, as our experience is consistent with published statistics that indicate victims of financial crimes (i.e., organizations with embezzlement losses) are unlikely to be made whole, even after exhausting all recovery methods. For example, the Association of Certified Fraud Examiners’ (ACFE) 2024 Report to the Nations reported that 57% of occupational fraud victims recovered nothing, and only 13% recovered all losses.²

Similarly, a 2018 study by the United States Government Accountability Office (GAO) was conducted to determine the amount of restitution collected by the Department of Justice (DOJ) from criminal defendants. According to the GAO report, the DOJ collected $0.80 billion of restitution during the 2016 fiscal year while deeming $10.1 billion as collectible and a staggering $100.1 billion of outstanding restitution as uncollectible. Said differently, of the approximately $110 billion of federal restitution outstanding as of 2016, less than 10% was deemed collectible by the GAO, and less than 1% was actually collected in the same year.³

So where does all the money absconded in financial crimes go? Anecdotal evidence gleaned from multiple press reports indicates perpetrators spend the proceeds of their fraudulent schemes on “lifestyle” goods—i.e., luxury automobiles, extravagant vacations, and other personal expenditures—as opposed to assets that appreciate or hold their value or move the stolen funds to foreign jurisdictions, which complicates asset forfeiture efforts.

However, not all hope is lost. There are several ways for occupational fraud victims to be restored to their pre-fraud financial positions. Below is a summary of a few common recovery methods.

• Privately negotiated settlements between the perpetrator and victim.
• Civil judgements obtained through a court order.
• Proceeds from fidelity bond insurance policies carried by the victim organization and
• Civil actions against potentially negligent parties (i.e., gatekeepers).

The complexity and unpredictability of fraud investigations underscore the critical importance of robust internal controls and vigilant oversight. The case studies and statistics illustrate that while recovery of misappropriated assets is challenging and often incomplete, there are structured pathways available for organizations to mitigate losses and reinforce defenses against future fraud. Organizations must prioritize strengthening their internal control environments, adhere to insurance requirements, and consider all available recovery options to effectively navigate the aftermath of financial crimes. As forensic accounting continues to evolve, these foundational strategies remain essential for safeguarding assets and ensuring financial integrity.

Sources

1. ‘Biggest Fraud in a Generation’: The looting of the COVID relief plan known as PPP. NBC News, March 28, 2022.
2. ACFE 2024 Report to the Nations. See Figure 60: How Successful Were Organizations at Recovering Losses from Fraud?
3. U.S. GAO February 2018 Report. See Figure 2: Collected and Outstanding Federal Criminal Restitution at the End of Fiscal Years 2014 through 2016.