The Risk Assessment – A Recipe for Greater Success!

Opening

We live in a disruption-intensive world and complacency is no longer an option!

To support my statement is the DOJ and their writing on the Evaluation of Corporate Compliance Programs (“Evaluation”), which states “prosecutors should also consider ‘[t]he effectiveness of the company’s risk assessment and the manner in which the company’s compliance program has been tailored based on that risk assessment’ and whether its criteria are ‘periodically updated.’

(See, e.g., [Justice Manual]  9-47-120(2)(c); [Sentencing Guidelines] § 8B2.1(c) (‘the organization shall periodically assess the risk of criminal conduct and shall take appropriate steps to design, implement or modify each requirement [of the compliance program] to reduce the risk of criminal conduct’.”)

The Evaluation further states, “prosecutors may credit the quality and effectiveness of a risk-based compliance program that devotes appropriate attention and resources to high-risk transactions, even if it fails to prevent an infraction in a low-risk area.

When the original Federal Sentencing Guidelines for Organizations (“the Sentencing Guidelines”) were issued in 1991, there was no mention of a risk assessment as part of compliance programs. It was not until the Sentencing Guidelines were amended in 2004 that this alarming omission was remedied. But even then, the risk assessment had not fully “arrived,” as some of the early compliance program requirements in FCPA settlements failed to include a risk assessment component.

As risks continue to expand and intensify many struggle to ring-fence them in and manage them appropriately. Relying on manual processes like spreadsheets, email, and other disparate methods more likely than not are not effective.

The recipe below must be adapted accordingly. Also, the risks that are identified need to be monitored appropriately. I suggest you strongly evaluate and consider automating, where possible, the management of risks and controls with the mindset of continuous improvement or tuning of the fraud risk management program.

Risk Assessment

In addition to establishing an ethical environment, board members and management must also take the lead in implementing and maintaining a formal fraud risk management program. One key element of such a program is a fraud risk assessment, which should be updated annually at a minimum or more frequently if conditions warrant.  Recall that GRC means, Governance, Risk, and Compliance because it’s a waterfall concept – meaning that good governance includes risk management, and risk management should be driving the compliance initiative or program.  Why? Because how can you design an effective compliance program to deter and detect ethical breaches, or worse, fraud, including  bribery and corruption, unless you understand the risks your organization faces.

IMG_0879 2

The risk assessment, which some say is easy and I disagree, should identify at a minimum fraud schemes and the acts that could potentially occur, possible concealment strategies that could be used by the fraudster to avoid detection, possible conversion tactics, the individuals or gatekeepers who pose the highest risk of committing fraud, controls that are in place to deter or detect fraud and a list of warning signals or “red flags” that are useful in many ways, including assessing the design of controls.

The success of the fraud risk assessment process hinges on how effectively the results are reported and what the organization then does with those results – in other words, “How is it operationalized”? – See Practice Pointer below.

Here is My Recipe or Methodology*

Having a documented risk-based methodology will help in many ways, including properly tailoring your internal audit and compliance programs.

——————————————-

Inventory the various risk assessments within the organizations. Ensure risk ratings are consistent.

Identify, understand, and evaluate the company’s business, their strategy, and operating environment along with the pressures that exist.

Understand the legal and regulatory aspects of your business.  For example:  If your organization is subject to the Foreign Corrupt Practices Act (“FCPA”) then your risk assessment will in all likelihood need to be expanded to include the appropriate elements to assess FCPA risk, which should focus on foreign government “touch points”.

Many miss here as they focus on sales/revenue. Sale volume and materiality shouldn’t matter – again focus on foreign government touch points!

Consider the strategy and objectives put forth.  This helps with assessing pressure and possible override then link the objectives to controls.

Evaluate and determine your Fraud Risk Universe (See graphic above).

Identify the business processes and consider differences across the organization.

Review prior allegations of fraud and actual frauds. Understand the root cause(s) of the actual frauds.

Consider at a minimum audit results (internal and external), investigations, results of root cause analysis, recent litigation or settlements, compliance complaints, employee claims, industry enforcement trends, and the existence and sufficiency of policies covering an area.

Identify the Process Owner for each Process and understand their duties and roles.  Throughout the risk assessment exercise consider segregation of duty conflicts and document them so they can be remediated.

Identify how Fraud may occur (fraud schemes) in each process and at each location through interviews and meetings.

Understand if the scheme involves financial statement fraud, asset misappropriation, or corruption.  Note:  It may include all three.

Look at the potential fraud manifestations (scenarios) within each process and location.

Identify the parties and profile (not stereotype) the individuals who have ability to commit the potential fraud. Process Owners, Gatekeepers, etc., who are competent and arrogant enough to possibly override/circumvent controls, if they exist, and misbehave.

Evaluate the likelihood that each of the identified frauds could occur and be significant/material as well as the persuasiveness of the potential fraud without considering controls and possibility of management override of those controls.

Consider the strategy to commit and conceal the fraud and the conversion to determine the effort / controls required to prevent, detect and deter the fraud.

Document the inherent risk.

Identify red flags by reviewing the fraud schemes, scenarios, concealment strategy, and conversion.  This helps in evaluating the controls that are or should be in place and the design. These “red flags” can be organized into four general categories:

Data

  • Transactions conducted at unusual times of day, on weekends or holidays or during a season when such transactions normally do not occur;
  • Transactions that occur more frequently than expected — or not frequently enough;
  • Accounts with many large, round numbers or transactions that are unusually large or small; and
  • Transactions with questionable parties, including related parties or unrecognized vendors, which may or may not be disclosed.

Documents

  • Missing or altered documents;
  • Evidence of backdated documents;
  • Missing or unavailable originals;
  • Documents that conflict with one another; and
  • Questionable or missing signatures.

Lack of Controls

  • Unwillingness to remediate gaps;
  • Inconsistent or nonexistent monitoring controls;
  • Lack of clear management position about conflicts of interest;
  • Inadequate segregation of duties;
  • Lax rules regarding transaction authorization; and
  • Failure to reconcile accounts in a timely manner.

Behavior

  • Rationalization, changes in behavior, contradictory behavior or recurring negative behavior patterns;
  • Lack of stability;
  • Inadequate income for the individual’s lifestyle;
  • Resentment of superiors and frustration with job;
  • Emotional trauma in home or work life;
  • Undue expectations from family, company or community; and
  • Attendance! Perfect attendance or severe absenteeism.
  • Determine the inherent risk.Evaluate the design of internal controls, if they exist.

Determine the appropriate audit response and investigate the characteristics of potential fraud manifestations within each process identified, where “Residual Fraud Risk” exists.

Determine the fraud risk expectancy (quantify).

Document the residual risk.

Remediate fraud risk by designing control activities or exiting/ending the activity, relationship, etc.  Use the “four eyes principle”.  Ensure there is an appropriate segregation of duties. Note: Also use this to insure you have proper insurance coverage.

Harmonize.  Make sure the fraud risks identified are evaluated similarly and are in sync with your Enterprise-wide Risk Assessment and other risk assessments you have done.  A savvy regulator will pick up on this and could conclude that from a governance perspective your risk management program is deficient – siloed.

Use the “red flags” identified as part of your training! Teach people what to look for and how to report any suspicious activity.

Review the fraud risk assessment frequently, especially after an event – like a fraud, change in senior leadership, merger, acquisition, reduction in force, system upgrade, etc.

IMG_0881

Practice Pointers

Compliance, internal audit, legal, and the organization’s stakeholders can use the results of, or operationalize, the fraud risk assessment, which includes the identified “red flags” to fine tune or strengthen controls, policies, procedures, training, and testing strategies/programs.

Closing

Risk assessments are critical today more than ever.

Having a risk assessment may help in resource allocation and prevent punishment for areas not in scope.

Please reach out to me if you have any comments or questions.

Best!

Jonathan

 

 

 

 

*Note: This is a standard approach. It has been customized and modified accordingly over the years. Also, for a complete assessment there are other procedures that more likely than not need to be performed in order to properly assess the risk of bribery and corruption.