KPMG FORENSIC

Fraud Risk Management

Developing a Strategy for Prevention, Detection,
and Response

A DV I S O RY

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
Contents

Foreword 1

Executive Summary 2

Defining Fraud and Misconduct 4

Convergence of Regulatory
Challenges 5

The Key Objectives: Prevention,

Detection, Response 6

Prevention 8

Detection 14

Response 17

An Ongoing Process 20

Conclusion 23

Appendix: Selected International

Governance and Antifraud Criteria 24

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 1

Foreword

Instances of corporate fraud and misconduct remain a constant threat to public trust
and confidence in the capital markets. As organizations strive to achieve compliance
with an array of new antifraud laws and regulations that are not prescriptive on the
design of controls in this area, managements agenda is focusing on efforts to:
Understand the fraud and misconduct risks that can undermine their business
objectives
Determine whether antifraud programs and controls are actually effective in
reducing instances of fraud and misconduct
Gain insight on better ways to design and evaluate controls to prevent, detect,
and respond appropriately to fraud and misconduct
Reduce exposure to corporate liability, sanctions, and litigation that may arise
from violations of law or market expectations
Derive practical value from compliance investments by creating a sustainable
process for managing risk and improving performance
Achieve the highest levels of business integrity through sound corporate gover-
nance, internal control, and transparency.

This white paper provides an overview of fraud risk management fundamentals,

identifies new regulatory mandates from around the world, and spotlights key
practices that organizations have generally found to be effective in the current
environment.

We hope this perspective provides fresh insights as you consider the risks of
fraud at home and abroad, and the effectiveness of controls you rely on to miti-
gate those risks.

Adam Bates
Global Chairman, KPMG Forensic SM

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
2 | F R A U D R I S K M A N A G E M E N T

Executive Summary

In the wake of high-profile corporate scandals as well as new regulations worldwide,

many business leaders are increasingly aware of the need to create company-specific
antifraud measures to address internal corporate fraud and misconduct. While
acknowledging that no single approach to fraud risk management can fit every orga-
nizations needs, this white paper spotlights key practices that organizations have
generally found to be effective when tailoring a company-specific antifraud program,
and offers a strategic approach to aligning corporate values with performance.

The Business Imperative

As companies achieve compliance with new antifraud laws and regulations, their
agendas center on managements efforts to:
Understand fraud and misconduct risks that can undermine their business
objectives
Reduce exposure to corporate liability, sanctions, and litigation
Achieve the highest levels of business integrity through sound corporate gover-
nance, internal control, and transparency.

Fraud: Any intentional act committed to secure an unfair or unlawful gain.

Misconduct: A broad concept, generally referring to violations of law, regula-

tions, internal policies, and market expectations of ethical business conduct.

Convergence of Regulatory Challenges

In recent years, a variety of laws and regulations have emerged worldwide, provid-
ing organizations with an array of criteria to incorporate into their antifraud efforts.
These laws include:
Australia: The Corporate Law Economic Reform Program (Audit Reform &
Corporate Disclosure) Act 2004
Canada: The Canadian Criminal Code
European Union: Financial Services Action Plan (FSAP)
United Kingdom: Companies (Audit, Investigations, and Community Enterprise)
Act of 2004
United States: The USA PATRIOT Act, the Foreign Corrupt Practices Act, the
Sarbanes-Oxley Act of 2002, SAS 99, various NYSE & NASDAQ listing standards,
and Public Company Accounting Oversight Board (PCAOB) Standard #2

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 3

The Key Objectives: Prevention, Detection, Response

An effective, business-driven fraud risk management approach encompasses
controls that have three objectives:
Prevent. Reduce the risk of fraud and misconduct from occurring.
Detect. Discover fraud and misconduct when it occurs.
Respond. Take corrective action and remedy the harm caused by fraud or
misconduct.

Pulling It All Together

The challenge for companies is to develop a comprehensive effort to:
Understand all of the various control frameworks and criteria that apply to them.
Categorize risk assessments, codes of conduct, and whistleblower mechanisms
into corporate objectives.
Create a broad ranging program that manages and integrates fraud prevention,
detection, and response efforts.

An Ongoing Process
Effective fraud risk management provides an organization with tools to manage risk
in a manner consistent with regulatory requirements as well as the entitys business
needs and marketplace expectations. Such an approach has four phases:
Assess Risks. Identify the scope of the analysis and key stakeholders, profile the
current state of fraud risk management, set targets for improvement, and define
steps necessary to close the gap.
Design. Develop a broad ranging program that encompasses controls to prevent,
detect, and respond to incidents of fraud or misconduct.
Implement. Deploy a strategy and process for implementing the new controls
throughout the organization and assign responsibility for leading the overall effort
to a senior individual.
Evaluate. Assess existing controls compared with legal and regulatory frame-
works as well as leading practices, such as internal investigation protocols or due
diligence practices.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
4 | F R A U D R I S K M A N A G E M E N T

Defining Fraud and Misconduct

Fraud is a broad legal concept that generally refers to an intentional act committed
to secure an unfair or unlawful gain.1 Misconduct is also a broad concept, generally
referring to violations of laws, regulations, internal policies, and market expectations
of ethical business conduct. Together, they fall into the following categories of risk
that can undermine public trust and damage a companys reputation for integrity:
Fraudulent financial reporting (e.g., improper revenue recognition, overstatement
of assets, understatement of liabilities)
Misappropriation of assets (e.g., embezzlement, payroll fraud, external theft,
procurement fraud, royalty fraud, counterfeiting)
Revenue or assets gained by fraudulent or illegal acts (e.g., over-billing customers,
deceptive sales practices, accelerated revenue, bogus revenue)
Expenses or liabilities avoided by fraudulent or illegal acts (e.g., tax fraud, wage
and hour abuses, falsifying compliance data provided to regulators)
Expenses or liabilities incurred for fraudulent or illegal acts (e.g., commercial or
public bribery, kickbacks)
Other misconduct (e.g., conflicts of interest, insider trading, discrimination, theft
of competitor trade secrets, antitrust practices, environmental violations)

Scandals and failures, together with flourishing and cynical greed, may have
profound and prolonged effects on public opinions. It is our collective duty
and well understood interest to demonstrate that market economy goes
together with integrity and common good.

Michel Prada
Chairman of the Autorit des Marchs Financiers French Securities Regulators
Global Public Policy Symposium
October 20, 2005

1
Bryan A. Garner, Editor, Blacks Law Dictionary, Eighth Edition, West Group, 2004

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 5

Convergence of Regulatory
Challenges

Governments around the world have responded to corporate scandals and fraudu-
lent activity by instituting legislative and regulatory reforms aimed at encouraging
companies to become more self-governing. In recent years, a variety of laws and
regulations have emerged, and the timeline in Figure 1 provides a selection of
important global regulations and events.

Note also that a summary of relevant regulations appears in Appendix: Selected

International Governance and Antifraud Criteria beginning on page 24.

Figure 1: A Timeline

Caremark
COSO Case
1992 1996

1980s 1990s 2000 2001 2002 2003 2004 2005

Commonwealth Corporations Act Sarbanes-Oxley U.S. Department Revised U.S. Revised

Criminal Code Act (Including CLERP Act of 2002 of Justice Sentencing Combined
1995 9 Amendments) Enforcement Guidelines Code with
2001 Proceeds of Guidance 2004 Turnbull,
U.S. Crime Act 2002 (Thompson Smith, and
Sentencing USA PATRIOT Act Memo) Higgs
Guidelines 2001 2003 Guidance
1991 2005/2006
NYSE and
Financial Services NASDAQ Listing
Action Plan Standards
1999 2003

U.S. Department The Combined

of Justice Code on
Enforcement Corporate
Guidance Governance
(Holder Memo) 2003
1999
The Money
Laundering
Regulations
Australia 2003
European Union
European Council
United Kingdom on Economic
Fraud
United States 2003

Source: KPMG LLP (U.S.), 2006

Undetected financial fraud is one of the greatest risks to an organizations

viability and corporate reputation, and it has the capacity to draw into its
sphere all associated people, not only the guilty.

Jeffrey Lucy
Chairman, Australian Securities and Investments Commission
November 10, 2005

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
6 | F R A U D R I S K M A N A G E M E N T

The Key Objectives: Prevention,

Detection, Response

An effective, business-driven fraud and misconduct risk management approach is one

that is focused on three objectives:
Prevention
Prevention: controls designed to reduce the risk of fraud and misconduct from
occurring in the first place
Detection: controls designed to discover fraud and misconduct when it occurs
Response Detection
Response: controls designed to take corrective action and remedy the harm
caused by fraud or misconduct

Putting It All Together

Just as there is an array of fraud and misconduct risks facing a company, there is an
array of control criteria that various regulatory programs require companies to adopt.
The challenge for companies, therefore, is to adopt a comprehensive and integrated
approach that takes all relevant considerations into account and enables them to work
together. Doing so helps avoid duplicative effort, resource fragmentation, and slip-
page between the cracks associated with a one-off or silo approach.

Such an undertaking begins with understanding all of the various control frameworks
and criteria that apply to the company (see Figure 2). When this categorization is
complete, the organization has the information it needs to create a comprehensive
program in which the elements of prevention, detection, and response can be inte-
grated and managed.

Figure 2: Selected International Standards

Jurisdiction Framework Relevance

Australia Corporations Act 2001 Aims to strengthen the financial reporting

(including CLERP 9 framework.
Amendments)

Canada The Multilateral Instrument Promotes an internal control culture for

52-109 improving the quality of financial reporting in
Canada.

Netherlands Corporate Governance Seeks to improve transparency in shareholder

Prevention
Code of Conduct 2004 and management relations as well as the
structure and accountability of management in
the Netherlands.

United Kingdom The Companies Act Aims to improve the reliability of financial Response Detection
of 2004 reporting and the independence of auditors and
auditor regulation in the United Kingdom.

United States Sarbanes-Oxley Act Introduced substantial changes to the corporate

of 2002 governance and financial disclosure requirements
of organizations registered with the Securities
and Exchange Commission and listed on U.S.
stock exchanges.

Source: KPMG LLP (U.S.), 2006

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 7

Figure 3 lists sample elements of a comprehensive program designed to prevent,

detect, and respond to fraud.

Figure 3: Sample Antifraud Program Elements

Prevention Detection Response

Board/audit committee oversight

Executive and line management functions
Internal audit, compliance, and monitoring functions

Fraud and misconduct Hotlines and whistle- Internal investigation

risk assessment blower mechanisms protocols
Code of conduct and Auditing and monitoring Enforcement and
related standards Proactive forensic data accountability
Employee and third- analysis protocols
party due diligence Disclosure protocols
Communication and Remedial action
training protocols
Process-specific fraud
risk controls

Source: KPMG LLP (U.S.), 2006

The next section spotlights some of the common control elements identified in
Figure 3 and offers considerations for their design.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
8 | F R A U D R I S K M A N A G E M E N T

Prevention

Ass
essmen
t
Preventive controls are designed to help reduce the risk of
fraud and misconduct from occurring in the first place.
Prevention
luation

Design

Leadership and Governance

Board/Audit Committee Oversight
E va

Response Detection
An organizations board of directors plays an important role in the oversight and
Im implementation of controls to mitigate the risk of fraud and misconduct. The board,
plem on
entati
together with management, is responsible for setting the tone at the top and
ensuring institutional support is established at the highest levels for ethical and
responsible business practices.

Directors have not only a fiduciary duty to ensure that an organization has programs
and controls in place to address the risk of wrongdoing but also a duty to ensure
that such controls are effective.2

As a practical matter, the board may delegate principal oversight for fraud and miscon-
duct risk management to a committee (typically audit), which is tasked with, among
other things:
Reviewing and discussing issues raised during the entitys fraud and misconduct
risk assessment
Reviewing and discussing with the internal and external auditors findings on the
quality of the organizations antifraud programs and controls
Establishing procedures for the receipt and treatment of questions or concerns
regarding questionable accounting or auditing matters.3

A robust fraud strategy is one that is sponsored at the highest level within a
firm and embedded within the culture. Fraud threats are dynamic and fraud-
sters constantly devise new techniques to exploit the easiest target.

Philip Robinson
Financial Crime Sector Leader, Financial Services Authority
February 27, 2006

2
In re Caremark Intl Derivative Litig., Del. Ch., 698 A.2d 959 (1996).
3
A listed companys audit committee must establish procedures for the receipt, retention, and treatment of complaints
regarding accounting, internal accounting controls, or auditing matters, and allow for the confidential, anonymous submission
by employees of concerns regarding questionable accounting or auditing matters. See Exchange Act section 10A(m)(4) and
SEC Rule 10A-3(b)(3), effective April 2003, which may be found at [Link]

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 9

Senior Management Oversight

To help ensure that fraud and misconduct controls remain effective and in line with Achieving good corporate gover-
governmental standards, responsibility for the organizations fraud and misconduct nance is not solely the responsi-
risk management approach should be shared at senior levels (i.e., individuals with bility of the directors, investors
and regulators; it should be a
substantial control or a substantial role in policy-making). This critical oversight
core objective of senior manage-
begins with prevention and must also be part of detection and response efforts. ment. Poor corporate gover-
nance weakens a companys
The chief executive officer is ideally positioned to influence employee actions through potential and at the worst can
his or her executive leadership, specifically by setting the ethical tone of the organiza- pave the way for financial diffi-
culties and even fraud.
tion and playing a crucial role in fostering a culture of high ethics and integrity. For
instance, the chief executive can lead by example, allocating resources to antifraud
Bill Witherell
efforts and holding senior management accountable for compliance violations. Director for Financial and
Enterprise Affairs
Direct responsibility for antifraud efforts should reside with a senior leader, often Organisation for Economic
Co-operation and Development
a chief compliance officer who works together with internal audit staff and desig-
CFO Strategies: Corporate
nated subject matter experts. The chief compliance officer is responsible for coordi- Accountability Forum 2004,
nating the organizations approach to fraud and misconduct prevention, detection, May 17, 2004

and response. When fraud and misconduct issues arise, this individual can draw
together the right resources to deal with the problem and make necessary opera-
tional changes. The chief compliance officer may also chair a committee of cross-
functional managers who:
Coordinate the organizations risk assessment efforts
Establish policies and standards of acceptable business practice
Oversee the design and implementation of antifraud programs and controls
Report to the board and/or the audit committee on the results of the organiza-
tions fraud risk management activities.

Other business leaders such as department heads (e.g., product development,

marketing, regulatory affairs, human resources) should also participate in responsi-
bilities under the organizations antifraud strategy; they oversee areas of daily opera-
tions in which risks arise. Such department heads can serve as subject matter experts
to assist the chief compliance officer with respect to their particular areas of expert-
ise or responsibility.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
1 0 | F R A U D R I S K M A N A G E M E N T

Internal Audit Function

The modern organizations internal audit function is a key participant in antifraud activ-
ities, supporting managements approach to preventing, detecting, and responding to
fraud and misconduct. KPMGs 2003 Fraud Survey notes that 65 percent of respon-
dents indicated that frauds were uncovered through the work of internal audit. Such
responsibilities represent a change from the more traditional role of internal audit
(that is, examining the effectiveness of the entitys controls). In general, internal audit
should be responsible for:
Planning and conducting the evaluation of design and operating effectiveness of
antifraud controls
Assisting in the organizations fraud risk assessment and helping draw conclusions
as to appropriate mitigation strategies
Reporting to the audit committee on internal control assessments, audits, investi-
gations, and related activities.

Fraud and Misconduct Risk Assessment

All organizations typically face a variety of fraud and misconduct risks. Like a more
conventional entity-wide risk assessment, a fraud and misconduct risk assessment
helps management understand the risks that are unique to its business, identify
gaps or weaknesses in control to mitigate those risks, and develop a practical plan
for targeting the right resources and controls to reduce risk.

Management should ensure that such an assessment is conducted across the

entire organization, taking into consideration the entitys significant business units,
processes, and accounts.

With input from control owners as to the relevant risks to achieving organizational
objectives, a fraud and misconduct risk assessment includes the steps listed in
Figure 4.

Figure 4: Fraud Risk Assessment Process

Source: KPMG LLP (U.S.), 2006

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 1 1

While management is responsible for performing a targeted risk assessment process

and considering its results in evaluating control effectiveness, the audit committee
typically has an oversight role in this process. The audit committee is responsible for
reviewing managements risk assessment, ensuring that it remains an ongoing effort,
and interacting with the entitys independent auditor to ensure that assessment
results are properly communicated.

Code of Conduct

52%
An organizations code of conduct is one
of the most important communications
vehicles that management can use to
Percentage of U.S. employees
communicate to employees on key stan- who reported that their codes of
dards that define acceptable business conduct are not taken seriously.
conduct. A well-written and communi- KPMG Forensic Integrity Survey
cated code goes beyond restating 2005 2006
company policiessuch a code sets the
tone for the organizations overall control
culture, raising awareness of managements commitment to integrity and the
resources available to help employees achieve managements compliance goals.4

A well-designed code of conduct typically includes:

High-level endorsement from the organizations leadership, underscoring a
commitment to integrity
Simple, concise, and positive language that can be readily understood by all
employees
Topical guidance based on each of the companys major policies or compliance
risk areas
Practical guidance on risks based on recognizable scenarios or hypothetical
examples
A visually inviting format that encourages readership, usage, and understanding
Ethical decision-making tools to assist employees in making the right choices
A designation of reporting channels and viable mechanisms that employees can
use to report concerns or seek advice without fear of retribution.

I submit that having a code of ethics that is not vigorously implemented is

worse than not having a code of ethics. It smacks of hypocrisy.

Roel C. Campos
Commissioner, U.S. Securities and Exchange Commission
October 16, 2002

4
Both the NYSE and the NASDAQ have adopted corporate governance rules that require U.S.-listed companies to adopt and
disclose codes of conduct for directors, officers, and employees, and disclose code waivers for directors or executive offi-
cers. NYSE Rule 303A(1) may be found at [Link]/about/listed/[Link], and NASDAQ Rule 4350(n) may
be found at [Link]

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
1 2 | F R A U D R I S K M A N A G E M E N T

Employee and Third-Party Due Diligence

An important part of an effective fraud and misconduct prevention strategy is the use
of due diligence in the hiring, retention, and promotion of employees, agents, vendors,
and other third parties. Such due diligence may be especially important for those
employees identified as having authority
over the financial reporting process.

The scope and depth of the due dili-

gence process typically varies based
49%
Percentage of U.S. employees
on the organizations identified risks, who reported that they would
the individuals job function and/or level be rewarded based on results,
of authority, and the specific laws of not the means used to achieve
them.
the country in which the organization
resides.5 KPMG Forensic Integrity Survey
2005 2006
There are certain situations where
screening third parties may be valid. For
example, management may wish to screen agents, consultants, or temporary work-
ers who may access confidential information or acquisition targets that may have
regulatory or integrity risks that can materially affect the value of the transaction.

Due diligence begins at the start of an employment or business relationship and

continues throughout. For instance, taking into account behavioral considerations
such as adherence to the organizations core valuesin performance evaluations
provides a powerful signal that management cares about not only what employees
achieve but also that those achievements were made in a manner consistent with
the companys values and standards.

Communication and Training

Making employees aware of their obliga-
tions concerning fraud and misconduct
control begins with practical communi-
55%
Percentage of U.S. employees
cation and training. While many organi-
who reported that they lacked
zations communicate on such issues in understanding of the standards
an ad hoc manner, efforts taken without of conduct that apply to their
planning and prioritization may fail to jobs.
provide employees with a clear message KPMG Forensic Integrity Survey
that their control responsibilities are to 2005 2006
be taken seriously.

5
One of the minimum requirements announced by the sentencing guidelines for organizational defendants calls for the organi-
zation to use reasonable efforts and exercise due diligence to exclude individuals from positions of substantial authority who
have engaged in illegal activities. See United States Sentencing Commission, Guidelines Manual, 8B2.1(b)(3) (Nov. 2004)
available at [Link]

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 1 3

In formulating a training and communications plan, management should consider

developing fraud and misconduct awareness initiatives that are:
Comprehensive and based upon job functions and risk areas
Integrated with other training efforts, whenever possible
Effective in a variety of settings, using multiple methods and techniques
Regular and frequent, covering the relevant employee population.

Senior management must move from thinking about compliance as chiefly

a cost center to considering the benefits of compliance in protecting
against the legal and reputational risks that can have an impact on the
bottom line.

Susan Schmidt Bies

U.S. Federal Reserve Board Governor
The Bank Administration Institutes Fiduciary Risk Management Conference 2004
Current Issues in Corporate Governance
April 26, 2004

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
1 4 | F R A U D R I S K M A N A G E M E N T

Detection

Ass
essmen
t
Detective controls are designed to uncover fraud and miscon-
duct when it occurs.
Prevention
luation

Mechanisms for Seeking Advice and Reporting Misconduct

Design

With the oversight and guidance of senior management, organizations tend to

E va

Response Detection provide employees with multiple channels for reporting concerns about fraud or
misconduct. Many typically request that employees follow a process that would
Im
plem on
entati begin with alerting their own managers, if possible, or a designated human
resources or compliance officer. Telephone hotlines are often made available and
can be used at any time, although they are usually intended for use when the
normal channels are impractical or ineffective. A hotline typically provides a viable
method whereby employees, and other third-parties if applicable, are encouraged to:
Communicate concerns about potential fraud and misconduct, including question-
able accounting or auditing matters
Seek advice before making decisions when the appropriate course of action is
unclear.

A well-designed hotline typically includes the following features:

Confidentiality. All matters reported via the hotline are treated confidentially.
Hotline operators inform callers that their concerns will be reported only on a
need to know basis and that relevant safeguards are in place to ensure that
such confidentiality is maintained. Hotline operators notify callers if the confiden-
tiality of the matter is subject to any legislative limitations.
Anonymity. The organizations protocols allow for the anonymous submission and
resolution of calls. For instance, callers who wish to remain anonymous are given
a case tracking number that they can later use to provide additional details related
to their question or allegation and/or check the status or outcome of their call.
Organization-wide Availability. Employees at international locations are able
to use the hotline through features such as real-time interpreting and toll-free
call routing.
Real Time Assistance. The hotline is designed to provide an immediate, live
response to a call to facilitate thorough and consistent treatment of a callers
question or concern as well as to provide immediate guidance. Thus, hotline oper-
ators need to be appropriately qualified, trained, and, in some situations, author-
ized to provide advice.
Data Management Procedures. The hotline operator uses consistent protocols
for gathering relevant facts and managing the hotline calls.
Classification of Financial Reporting Concerns. The hotline includes protocols
whereby qualified individuals (e.g., internal audit, legal, security) can determine
whether the nature of an allegation could trigger a financial reporting risk.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 1 5

Audit Committee Notification. The hotline includes protocols that specify the
nature and timing of allegations that are escalated to the audit committee.
Follow-up on Non-retaliation. The organizations protocols allow for following up
with employees periodically after the hotline case has been closed (e.g., at one-,
three-, and six-month intervals) to ensure that reporting employees have not expe-
rienced retaliation. The company encourages the employees to report any
instances of retaliation and takes swift action against those who do retaliate.
Prominent Communications. The organization publicizes its hotline prominently.
Such communications may include, among others, (1) describing the hotline
within the code of conduct and other key company publications and training; (2)
displaying the hotline telephone number on posters, banners, wallet cards, screen
savers, telephone directories, or desk calendars; and (3) communicating mini-
case-studies based on hotline calls to employees (e.g., in newsletters, training
programs, or intranet sites) to demonstrate that the organization values hotline
calls and is able to provide assistance to those who use the hotline.

Auditing and Monitoring

Auditing and monitoring systems that are reasonably designed to detect fraud and
misconduct are important tools that management can use to determine whether
the organizations controls are working
as intended. Since it is impossible to
audit every fraud and misconduct risk,
management should develop a compre-
33%
hensive auditing and monitoring plan Percentage of Australia/New
that is based on risks identified through Zealand employees reporting
that early warnings of fraud
the organizations fraud risk assess-
problems were ignored.
ment process.
KPMG Fraud Survey 2004
An auditing and monitoring plan should
thus encompass activities that are
tailored in depth to the nature and degree of the risk involved, with higher-risk issues
receiving priority treatment. Auditing activities (an evaluation of past events) and
monitoring activities (an evaluation conducted real-time) should be performed in, but
are not limited to, areas where:
There are specific concerns about a key procedure, account, or position
The company has a history of fraud and misconduct
There is high employee turnover or organizational change
Laws and regulations have changed significantly
Audits are legally required, or governmental agencies are targeting enforcement
actions.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
1 6 | F R A U D R I S K M A N A G E M E N T

An organizations managers involved in auditing and monitoring efforts should not

only have sufficient training and experience but also be seen as objective in evaluat-
ing the controls for which they are responsible. Optimally, auditing and monitoring
protocols should:
Occur in the ordinary course of operations, including during regular management
and supervisory activities
Draw on external information to corroborate internally generated information
Formally communicate identified deficiencies and exceptions to the organizations
senior leadership, so that the harm to the organization is appropriately understood
and mitigated
Use results to enhance and modify other controls, such as communications and
training, performance evaluations, and discipline.

Proactive Data Analysis

Many of the indicators of fraud and The ability to consider and analyze thou- Create a methodology to acquire, extract,
misconduct, both actual and potential, sands of transactions in less time, more and evaluate the data
reside within an organizations financial, efficiently, and cost-effectively than Define the analyses to be performed
operational, and transactional data, and can using more traditional forensic sampling Select software tools to be used in
be identified using data analysis tools and techniques performing the analysis
techniques. Such proactive data analysis The ability to consider a companys Perform the analysis, aggregate and
uses sophisticated analytical tests, unique organizational and industry issues. prioritize the results, and review and
computer-based cross matching, and non- resolve the exceptions identified.
obvious relationship identification to high- Transactions can be analyzed using either
light potential fraud and misconduct that retrospective or continuous transaction Unlike retrospective-based analyses,
can remain unnoticed by management, monitoring. Retrospective analyses allow continuous transaction monitoring allows
often for years. The benefits of such an organizations to analyze transactions in one- an organization to identify potentially fraud-
analysis may include, among others: or two-year increments, enabling organiza- ulent transactions on, for example, a daily,
Identification of hidden relationships tions to discern patterns that are not visible weekly, or monthly basis. Organizations
between people, organizations, and with shorter-term analyses. Creating the frequently use continuous monitoring efforts
events capability to perform retrospective-based to focus on narrow bands of transactions or
A means to analyze suspicious proactive forensic data analysis includes areas that pose particularly strong risks.
transactions steps to:
An ability to assess the effectiveness Assess the fraud risk profile of systems
of internal controls intended to prevent or processes
or detect fraudulent activities Define the overall objectives of the
The potential to continually monitor analysis
fraud threats and vulnerabilities

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 1 7

Response

Ass
essmen
t
Response controls are designed to take corrective action and
remedy the harm caused by fraud or misconduct.
Prevention
luation

Investigations
Design

When information relating to actual or potential fraud and misconduct is uncovered,

E va

Response Detection management should be prepared to conduct a comprehensive and objective internal
investigation. The purpose of such an investigation is to gather facts leading to a credi-
Im
plem on ble assessment of the suspected violation, so management can decide on a sound
entati
course of action.

By conducting an effective internal investigation, management can address a poten-

tially troublesome situation and have an opportunity to avert a potentially intrusive
government investigation. A well-designed investigative process will typically include
the following attributes, among others:
Oversight by the organizations audit committee, or a special committee of the
board, either of which must comprise independent directors who are able to ward
off undue pressure or interference from management
Direction by outside counsel, selected by the audit committee, with little or no ties
to the entitys management team, and that can perform an unbiased, independ-
ent, and qualified investigation
Vetting by the organizations external auditor so that the latter can rely on the
proposed scope of work in the audit of the organizations financial statements
A full-cooperation requirement, allowing no employee or member of management
to obscure the facts that gave rise to the investigation
Reporting protocols, providing the external auditors, regulators, and, where appro-
priate, the public with information relevant to the investigations findings in a spirit
of cooperation and transparency.

Based on a number of factors, including the nature of the potential illegal act, parties
involved, and materiality, the organization may decide to use one or more of the
above steps. Management would consult with the appropriate oversight functions
and internal protocols to determine the steps that best address the allegation.

Enforcement and Accountability

A consistent and credible disciplinary
system is a key control that can be
effective in deterring fraud and miscon-
47%
duct. Appropriate discipline is, addition- Percentage of U.S. employees
who reported that wrongdoers
ally, a requirement under leading
would be disciplined fairly
regulatory frameworks. By mandating regardless of their position.
meaningful sanctions, management can
KPMG Forensic Integrity Survey
send a signal to both internal and exter-
2005 2006
nal parties that the organization consid-
ers managing fraud and misconduct risk
a top priority.
2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
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1 8 | F R A U D R I S K M A N A G E M E N T

A well-designed disciplinary process will be communicated to all employees and

include company-wide guidelines that promote:
Progressive sanctions consistent with the nature and seriousness of the offense
(e.g., verbal warning, written warning, suspension, pay reduction, location trans-
fer, demotion, or termination)
Uniform and consistent application of discipline regardless of rank, tenure, or
job function.

Holding managers accountable for the misconduct of their subordinates is another

important consideration. Managers may be disciplined in those instances where
they knew, or should have known, that fraud and misconduct might be occurring,
or when they:
Directed or pressured others to violate company standards to meet business
objectives or set unrealistic goals that had the same effect
Failed to ensure employees received adequate training or resources
Failed to set a positive example of acting with integrity or had a prior history of
missing or permitting violations
Enforced company standards inconsistently or retaliated against others for report-
ing concerns.

Corrective Action
Once fraud and misconduct has occurred, management should consider taking action
to remedy the harm caused. For example, management may wish to consider taking
the following steps, among others, where appropriate:
Voluntarily disclosing the results of
the investigation to the government or
other relevant body (i.e., a regulator)
Remedying the harm caused
Examining the root causes of the rele-
63%
Percentage of Australian/New
vant control breakdowns, ensuring
Zealand organizations that
that risk is mitigated and that controls reported the incident to the
are strengthened police.
Administering discipline to those KPMG Fraud Survey 2004
involved in the inappropriate actions
as well as to those in management
positions who failed to prevent or detect such events
Communicating to the wider employee population that management took appro-
priate, responsive action.

Although public disclosure of fraud and misconduct may be embarrassing to an organi-

zation, management may nonetheless wish to consider such an action in order to
combat or preempt negative publicity, demonstrate good faith, and assist in putting
the matter to rest.
2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 1 9

To Charge or Not to Charge?

In deciding not to charge Seabord Corporation with violations of the federal securities
laws following an investigation of alleged accounting irregularities, the SEC announced
influential dictum that a companys self-policing, self-reporting, remediation, and coopera-
tion with law enforcement authorities, while no guarantee for leniency, would factor into
the prosecutorial decision-making process. Among other questions the SEC would be
asking the following:
Did the company promptly, completely, and effectively disclose the existence of the
misconduct to the public, to regulators, and to self-regulators?
Did the company cooperate completely with appropriate regulatory and law enforce-
ment bodies?
Did the company appropriately recompense those adversely affected by the conduct?
Did it do a thorough review of the nature, extent, origins, and consequences of the
conduct and related behavior?
Did the company promptly make available to our staff the results of its review and
provide sufficient documentation reflecting its response to the situation?
Did the company voluntarily disclose information our staff did not directly request and
otherwise might not have uncovered?
Did the company ask its employees to cooperate with our staff and make all reason-
able efforts to secure such cooperation?

Accounting and Auditing Enforcement, Exchange Act Release No. 44,969 (October 23,
2001). The release may be found at [Link]/litigation/investreport/[Link].

To Fine or Not to Fine?

In a related opinion on January 4, 2006, the SEC opined that in deciding the appropriate-
ness of a civil monetary penalty levied against a corporate settlement of action, the follow-
ing factors would be examined:
The presence or absence of a direct benefit to the corporation as a result of the
violation.
The degree to which the penalty will recompense or further harm the injured share-
holders.
The need to deter the particular type of offense.
The extent of the injury to innocent parties.
Whether complicity in the violation is widespread throughout the corporation.
The level of intent on the part of the perpetrators.
The degree of difficulty in detecting the particular type of offense.
Presence or lack of remedial steps by the corporation.
Extent of cooperation with Commission and other law enforcement.

Statement of the Securities and Exchange Commission Concerning Financial Penalties,

Release 2006-4 (January 4, 2006). The Statement may be found at [Link]
/news/press/[Link].

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
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the KPMG logo are registered trademarks of KPMG International.
2 0 | F R A U D R I S K M A N A G E M E N T

An Ongoing Process

An effective fraud risk management approach provides an organization with tools to

essmen
Ass t
help manage risk in a manner consistent with regulatory requirements as well as the

Prevention
entitys business needs and marketplace expectations. As described below, develop-
luation

ing such an approach can be achieved in key phases:

Design

Assessment of Risks. Assessing the needs of the organization based on the

E va

Response Detection
nature of fraud and misconduct that risk controls are intended to mitigate and
Im the adequacy of existing controls.
plem ion
entat
Design. Developing controls to prevent, detect, and respond to identified risks in
a manner consistent with legal and regulatory criteria and other leading practices.
Implementation. Deploying a process for implementing the new controls and
assigning responsibility to individuals with the requisite level of authority, objectiv-
ity, and resources to support the process.
Evaluation. Evaluating the design and operating effectiveness of controls through
control self-assessment, substantive testing, routine monitoring, and separate
evaluations.

Assessment
The nature of fraud and misconduct risks facing an organization can be as diverse
and fluid as the business itself. The risks of fraud and misconduct for a national bank
that has experienced rapid growth through acquisitions are different than those of a
global energy company seeking to expand crude exploration in emerging markets.
Therefore, antifraud measures should be tailored to the unique risks of an organiza-
tion, the specific conditions that give rise to those risks, and the targeted resource
needs required in balancing risk and control.

The first step is to determine what a companys fraud risks are and how effectively
the organization manages these risks. To get started, an organization would consider
which business units, processes, systems, and controls, among other factors, may
need to be included in the scope of the analysis. The organization can also identify
key stakeholders who may need to be involved. Once the organization profiles its
current state and sets targets for improvements, it can assess the gap it must
close to reach the desired state and begin defining the necessary steps to get there.

Design
The goal of the control design phase is for management to develop controls that will
operate effectively and protect the organization from the risk of fraud and misconduct.
However, for an entity to design effective controls, it must first tailor these controls
to the risks it is facing as well as the organizations unique business environment.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 2 1

When designing controls, management should endeavor to do more than observe

regulatory requirements (i.e., minimum criteria defined by various regulatory frame-
works). Rather, management should take into account the relevance of a variety of
leading practices (i.e., practices that similarly situated organizations have generally
found to be effective). Incorporating leading practices into the design of fraud controls
increases the likelihood that those controls will ultimately prove to be effective.

Each entity is unique and thus will have individualized control considerations.
Management would be well served to consider the organizations unique circum-
stances when designing fraud controls. Control attributes that may be appropriate
for a global telecommunications company may be inappropriate for a national bank,
and vice versa. Management should seek to design controls that satisfy not only
legal requirements but also the organizations distinct business needs.

Implementation
Once fraud controls have been designed, management should establish a strategy
and process for implementing the new controls throughout the organization and
assign to a senior individual responsibility and resources for leading the overall
effort. Meaningful and consistent implementation typically requires a substantial
change in workplace culture and practices. Therefore, employees should receive
clear and frequent communications with respect to when, how, and by whom the
controls will be rolled out as well as the manner with which compliance with the
new controls will be enforced.

Evaluation
Simply because a control exists is no guarantee that it is operating as intended. After
a control has been operating for a designated period of time, it should be evaluated
to determine whether it was designed and implemented to achieve optimal effective-
ness. Such an evaluation should first consider those controls identified as higher
risk before other, lower-priority controls.

On the other hand, simply because a particular control does not yet exist, manage-
ment should not automatically conclude that the organizations risk management
objective is not being met. In the absence of a specific control, other compensating
controls may be operating effectively and mitigating the risk of fraud and misconduct.

When evaluating the design effectiveness of a control, management should take

into account both regulatory requirements and leading practices that similarly situ-
ated organizations have found to correlate with effective risk mitigation. Management
can then use a gap analysis process to determine whether the control in question

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
2 2 | F R A U D R I S K M A N A G E M E N T

indeed incorporates the required design criteria. For instance, where a design crite-
ria calls for the organizations whistleblower hotline to allow anonymous submission
of questions or concerns regarding accounting and auditing matters, management
should seek to determine whether the hotline protocols indeed allow for caller
anonymity.

To evaluate the operational effectiveness of a particular control, management should

focus on the extent to which the controls objectives have been achieved. For exam-
ple, have the mitigation strategies identified during the fraud and misconduct risk
assessment been implemented properly? Similarly, management may have put in
place a well-designed code of conduct, but are employees actually using the code to
guide their day-to-day activities? In the end, the integrity climate will determine the
perceptions employees have of the ability of the organization to prevent, detect, and
respond to fraud and misconduct and base their own conduct on those perceptions.

Only when such basic questions are addressed can management focus on gathering
empirical data on control effectiveness using review and evaluation techniques (e.g.,
proactive forensic data analysis). For instance, management may wish to ascertain
whether employees truly understand the standards contained in the code of conduct
or whether employees feel comfortable calling the hotline. To gather such hard-to-
audit qualitative data, management may wish to field a survey of employee percep-
tions and attitudes. Such a survey can be a powerful tool, generating data that can
be benchmarked against prior-year results to note improvements and demonstrate
control effectiveness.

An organizations particular situation should be taken into account in conducting an

effectiveness evaluation, and such an inquiry should remain ongoing. Management
should continuously consider how its risk strategy and control effectiveness are
affected by changes in market expectations, external scrutiny, and regulatory or
legislative developments.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
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 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 2 3

Conclusion

Faced with an increasing array of rules and standards governing business conduct,
many organizations worldwide continue to struggle with how to mitigate the innu-
merable risks posed by fraud and misconduct.

The development of a broad ranging fraud risk management program is an impor-

tant step in managing this challenge. Organizations undertaking the effort should
begin by assessing how well they are managing fraud risk. Identifying known risks
and existing controls is an important first step. Then the organization can determine
its ideal future state, perform a gap analysis, and prioritize activities that will help
enable the development of a company-specific antifraud program.

Such a program will not only help enable appropriate compliance with regulatory
mandates but also help the organization align its corporate values and performance
as well as protect its many assets, including its reputation.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
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2 4 | F R A U D R I S K M A N A G E M E N T

Appendix: Selected International

Governance and Antifraud Criteria

Australia
Commonwealth Criminal Code Act (1995)
Boards have a responsibility to foster a culture of compliance with Australian law.
Under the Criminal Code, a company can be convicted of Commonwealth criminal
offenses if it is established that the company had a culture that directed or encour-
aged, tolerated, or led to noncompliance, or that the body failed to maintain a culture
that required compliance with relevant legislation. (Schedule, Part 2.5, Division 12)

Corporations Act 2001 (Including CLERP 9 Amendments) (2001)

Directors must exercise their powers and discharge their duties with care and dili-
gence. (Section 180)
CEO and CFO of a listed entity must make a declaration that:
An entitys financial records must be properly maintained in accordance with
the Act.
Financial statements for the financial year must comply with the accounting
standards.
Financial statements must present a true and fair view of the financial position
and performance of the entity. (Section 295A)

AUS 210 (2002)

Establishes a requirement for auditors to consider fraud and error in an audit of a
financial report. (AUS 210)

Australian Stock Exchange Guidance Note 9A (2003)

Requires the board or appropriate board committee to establish policies on risk over-
sight and management. (Principle 7)

Australian Standard 8001 2003 Fraud and Corruption Control (2003)

Provides guidance on fraud and corruption control that is considered best practice.

European Union
The Financial Services Action Plan (FSAP) (1999)
The FSAP is designed to create a single market in financial services throughout the
EU. Forty-two legislative measures were contemplated as part of the action plan,
many of which focused on securities regulation. As of 2004, these measures are
having a tremendous effect on the regulation of EU capital markets and, as with the
Sarbanes-Oxley Act, have necessitated major adjustments on the part of issuers,
accountants and lawyers, and regulators affected by the legislation.

Third Directive on the Prevention of the Use of the Financial System for Money
Laundering or Terrorist Financing (2005/60/EC)
Council Directive 2005/60/EC is an update to two earlier directives in response to
concerns about money laundering. This Directive requires member states to:
Fight against money laundering
Compel the financial sector, including credit institutions, to take various measures
to establish customers identities

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
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 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 2 5

Urge the financial sector to keep appropriate records

Establish internal procedures to train staff to report suspicions to the authorities
and to set up preventive systems within their organizations.

This Directive also introduces additional requirements and safeguards for situations
of higher risk (e.g., trading with correspondent banks situated outside the EU).

United Kingdom
The Financial Services and Markets Act (2000)
This Act supports the Financial Services Authoritys (FSAs) goal to reduce the likeli-
hood that business carried on by a regulated person, or in contravention of the
general prohibition, can be used for a purpose connected with financial crime. As a
result, the FSA requires senior management of regulated firms to take responsibility
for managing fraud risks, and firms to have effective systems and controls in place
proportionate to the particular financial crime risks that they face.

Proceeds of Crime Act (2002)

The Act has strengthened the law on money laundering and sets up an Assets
Recovery Agency to investigate and recover assets and wealth obtained as a result
of unlawful activity.

Combined Code on Corporate Governance (2003)

The Financial Reporting Councils (FRC) Combined Code on Corporate Governance
sets out standards of good practice in relation to issues such as board composition
and development, remuneration, accountability and audit, and relations with share-
holders. All companies incorporated in the United Kingdom and listed on the London
Stock Exchange are required under the Listing Rules to report on how they have
applied the Combined Code in their annual report and accounts, orwhere they
have notto provide an explanation.

The current version of the Combined Code was published in July 2003. In recent
years, related guidance has been issued including the Turnbull guidance on Internal
Control, revised in October 2005; the Smith guidance on Audit Committees; and the
Higgs guidance on good practices.

An implementation review carried out by the FRC in 2005 indicated the Code is having
a favorable impact on the quality of corporate governance. The results also turned up
no appetite for major change, and only two suggested amendments carried strong
support. The FRC began consulting on these amendments in January 2006. The main
proposals would be to relax the existing provisions to allow the chairman to sit on the
remuneration committee and to add a new provision regarding companies including a
vote withheld box on the annual general meeting (AGM) proxy voting forms, as
recommended by the Shareholder Voting Working Group. Consultation on possible
amendments to the Code closed on April 21, 2006. If implemented, the intention is
that changes would apply to financial years beginning on or after November 1, 2006.

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2 6 | F R A U D R I S K M A N A G E M E N T

The Money Laundering Regulations (2003)

In the United Kingdom, these regulations require various kinds of businesses to
identify their customers under specific circumstances and to retain copies of identi-
fication evidence for five years. These regulations apply to banks, check cashing
businesses, money transmitters, accountants, solicitors, casinos, estate agents,
bureaus de change, and dealers in high-value goods. Employers may be prosecuted
for a breach of these regulations if they fail to train staff.

United States
Director and Officer Liability (August 1996)
The Delaware Chancery Court in In re Caremark Intl Inc. Derivative Litigation held
that boards of directors that exercise reasonable oversight of a compliance program
may be eligible for protection from personal liability in shareholder civil suits result-
ing from employee misconduct. A directors fiduciary duty goes beyond ensuring
that a compliance program exists, but also includes a good faith duty to ensure that
the organizations compliance program is adequate.

Department of Justice Prosecution Policy (Original June 1999, revised January 2003)
The Department of Justices guidance (the Thompson Memo) instructs federal pros-
ecutors that while having in place a compliance program does not absolve a corpora-
tion from criminal liability, it may provide factors that can be used in determining
whether to charge an organization or only its employees and agents with a crime.
These factors include evaluating whether:
The compliance program is merely a paper program or is designed and imple-
mented effectively
Corporate management is enforcing the program or tacitly encouraging or pres-
suring employees to engage in misconduct to achieve business objectives
The corporation has sufficient staff to audit and evaluate results of its compliance
efforts
Employees are informed about the program and are convinced of the corporations
commitment to it.

Sarbanes-Oxley Act of 2002

The U.S. government had responded to widespread cases of corporate fraud and
misconduct by passing the Sarbanes-Oxley Act of 2002. The Act includes the follow-
ing sections, among others:
Section 301: Requires audit committees to establish procedures to receive, retain,
and treat complaints from employees and others about accounting, internal
accounting controls, or auditing matters.
Section 404: Management and external auditors are to evaluate the effectiveness
of a companys internal control over financial reporting based on a suitable control
framework.
Section 406: Instructs the SEC to issue rules requiring companies to either adopt
a code of ethics applicable to senior financial officers or disclose why they do not.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
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 D E V E L O P I N G A S T R A T E G Y F O R P R E V E N T I O N , D E T E C T I O N , A N D R E S P O N S E | 2 7

Section 806: Requires all companies regulated by the SEC to have in place a
mechanism whereby a whistleblower could report a violation of law or SEC rule,
and to protect from retaliation any person who uses that mechanism.
Section 1107: Provides penalties and/or fines for retaliating against any corporate
whistleblower, amending section 1513 of Title 18, United States Code.

Most companies in the United States are applying the integrated internal control
framework developed by the Committee of Sponsoring Organizations (COSO) of the
Treadway Commission for this purpose. Generally speaking, COSO addresses ethics
and compliance program elements in company-level components that have a perva-
sive influence on organizational behavior, such as the control environment. Examples
of company-level control considerations include:
Establishment of the tone at the top by the board and management
Existence of codes of conduct and other policies regarding acceptable business
practices
Extent to which employees are made aware of managements expectations
Pressure to meet unrealistic or short-term performance targets
Managements attitude toward overriding established controls
Extent to which adherence to the code of conduct is a criterion in performance
appraisals
Extent to which management monitors whether internal control systems are
working
Establishment of channels for people to report suspected improprieties
Appropriateness of remedial action taken in response to violations of the code
of conduct

NYSE Listing Standards Section 303A, Corporate Governance Standards (Modified,

November 2004)
Qualitative Listing Requirements for the NASDAQ National Market (Amended,
April 2004)
In response to the provisions of the Sarbanes-Oxley Act, both the NYSE and NASDAQ
adopted new corporate governance rules for listed companies. While the specific
rules for each exchange differ, each have standards that require listed companies to
(1) adopt and disclose codes of conduct for directors, officers, and employees and
(2) disclose any code of conduct waivers for directors or executive officers. In addi-
tion, each exchange requires listed companies to adopt mechanisms to enforce their
codes of conduct.

U.S. Sentencing Guidelines Criteria (Amended, November 2004)

The federal sentencing guidelines for organizational defendants establish minimum
compliance and ethics program requirements for organizations seeking to mitigate
penalties for corporate misconduct. These guidelines make explicit the expectation
that organizations promote a culture of ethical conduct, tailor each program element
based on compliance risk, and periodically evaluate program effectiveness.
2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
2 8 | F R A U D R I S K M A N A G E M E N T

Specifically, the amended guidelines call on organizations to:

Promote a culture that encourages ethical conduct and a commitment to compli-
ance with the law
Establish standards and procedures to prevent and detect criminal conduct
Ensure the board of directors and senior executives exercise reasonable and
informed oversight over the compliance and ethics program
Assign a high-level individual within the organization to ensure the organization
has an effective compliance and ethics program, and delegate day-to-day opera-
tional responsibility to individuals with adequate resources, authority, and direct
access to the board
Use reasonable efforts and exercise due diligence to exclude individuals from
positions of substantial authority who have engaged in illegal activities or other
conduct inconsistent with an effective compliance and ethics program
Conduct effective training programs for directors, officers, employees, and other
agents and provide such individuals with periodic information appropriate to their
respective roles and responsibilities relative to the compliance and ethics program
Ensure that the compliance and ethics program is followed, including monitoring
and auditing to detect criminal conduct
Publicize a system, which may include mechanisms for anonymity and confiden-
tiality, whereby the organizations employees and agents may report or seek guid-
ance regarding potential or actual misconduct without fear of retaliation
Evaluate periodically the effectiveness of the compliance and ethics program
Promote and enforce consistently the compliance and ethics program through
incentives and disciplinary measures
Take reasonable steps to respond appropriately to misconduct, including making
necessary modifications to the compliance and ethics program.

2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.
Key Contacts

Tim Hedley
Partner
KPMG LLP in the United States
thedley@[Link]
+1 212 872 3496

Gary Gill
Partner
KPMG in Australia
ggill@[Link]
+61 (2) 9335 7312

Jack de Raad
Partner
KPMG in the Netherlands
[Link]@[Link]
+31 20 656 7774

KPMG contributors to this publication include Richard Girgenti, Ori Ben-Chorin, Jim Littley, Graham Murphy,
Scott Avelino, Raymond Dookhie, Joel Dziengielewski, Justin Snell, Melissa Dugan, William Rudolph,
Jaime Jue, Brad Sparks, Donna Tamura, Remco de Groot, Jack de Raad, Gary Gill, Tim Hedley, Martijn Hin,
Muel Kaptein, Carole Law, Peter Morris, Diane Nardin, Shae Roberts, and Aaron Sparks.

The information contained herein is of a general nature and is not intended to address the circumstances
of any particular individual or entity. Although we endeavor to provide accurate and timely information,
there can be no guarantee that such information is accurate as of the date it is received or that it will con-
tinue to be accurate in the future. No one should act on such information without appropriate professional
advice after a thorough examination of the particular situation.

Visit KPMG on the World Wide Web at [Link].

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work of independent firms are affiliated with KPMG International. KPMG International provides no client
services. No member firm has any authority to obligate or bind KPMG International or any other member
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 2006 KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent firms operating under the KPMG name. KPMG
International provides no services to clients. Each member firm of KPMG International is a legally distinct and separate entity and each describes itself as such. All rights reserved. KPMG and
the KPMG logo are registered trademarks of KPMG International.