By William W. Acuff, CPA, CFF, CFE, CIA, CGMA
In recent years it seems instances of white collar crime has become a daily news event. While much of the news about white collar crime involves identify theft or credit card fraud, the rate of corporate white-collar crime continues to grow at alarming rates.
The Association of Certified Fraud Examiners estimate a typical organization will lose annually an amount up to 5% of their revenues due to dishonesty from within. Internal fraud affects almost every company, regardless of its size or industry, and those that fail to implement procedures and processes that prevent and detect fraudulent activity are assuming significant risks. Not only are the risks from tangible losses, but also risks of morale and reputation losses.
The best way to deal with risks is to eliminate or minimize its effect. The first step in preventing and detecting fraud risk is understanding its characteristics and how it affects your company.
The following ten things will help you better understand how to deal with and manage internal fraud risks.
1. Anyone Can Commit Fraud. One of the biggest problems I encounter in fighting fraud is denial. Many business owners are blinded by the fact that up to 80% of us are capable of committing fraud, given the right pressures and the opportunity.
Fraud perpetrators are usually some of the most trusted individuals with whom victims associate.
Almost all employees, managers, executives, business partners and even family members are capable of committing fraud. The problem is, we never know who or when that may happen.
People ask me what are the characteristics of a fraud perpetrator, or what does a fraud perpetrator look like. I tell them they look just like you and me.
2. More than 90% of persons charged with fraud, had never been charged before. Most companies conduct background checks on employees, especially when filling sensitive positions. Yet despite conducting background checks, more than 90% of fraud perpetrators have no prior criminal history.
Something is causing or allowing basically honest employees to engage in inappropriate behavior.
3. We place too much trust in our employees. This is especially true with in small businesses. Small business continues to suffer a disproportionate amount of losses per fraud scheme. According to the Association of Certified Fraud Examiners’ 2006 Report To the Nation, the average loss for an asset misappropriation scheme is $150,000, but for small businesses the average loss is $190,000. This is due, mainly to the fact that small business many times do not have the necessary number of employees to provide an adequate separation of duties which allows the proper checks and balances.
So often we temp our employees by allowing them access to assets without anyone checking to see if all is well.
Mark Twain said, “Trust everyone, just make sure you cut the cards.” Ronald Regan said, “Trust, but verify.” Whenever you give employees access to assets, make sure they are properly accountable for those assets.
4. The three elements of fraud are present when people commit fraud. This is the case for most of internal frauds.
Fraud is like fire in that there are three elements, fuel, heat and oxygen, which comprise a fire triangle. Eliminate anyone of the three fire elements and there is no fire. The fraud triangle, consisting of pressure, opportunity and rationalization, works the same way. Anytime one of these elements are eliminated, fraud cannot take place:
Pressure. This element can also be called, incentive or motivation. Many times the pressure is of a non-sharable, financial nature, such as an employee getting into excessive debt. But also, it could be workplace dissatisfaction, or increasingly, just plain greed; the desire to lead an extravagant lifestyle.
Opportunity. If you don’t have the opportunity to engage in fraudulent behavior without getting caught, you won’t. Remember, perception is reality. So, the best way to prevent fraud, is to increase the perception that the fraud will be detected. However, many times the opportunity is created when the fraudster tricks or deceives fellow employees who’s
Rationalization. We all use rationalization in life. If there is sufficient pressure and the opportunity is present, most of us could rationalize that the fraudulent behavior is alright. Especially, when we tell ourselves that its for a good cause or we are just borrowing the money; it’s not like robbing a bank; besides no one is getting hurt.
5. Promote ethical behavior. In the final analysis, a company that emphasizes ethical conduct will make more difference than all of the regulations, policies or procedures mandated or adopted. Studies have shown that companies that promote ethics are more profitable than others. If you want people to behave honestly, you must you model appropriate behavior.
Not only must you model appropriate behavior, you must also label it. A clearly defined code of ethics defines what is acceptable and what is not acceptable, and clearly defined codes of ethics also help inhibit rationalizations which is one of the factors in the fraud triangle.
Take the time to hire the right employee and then create an environment which helps prevent good employees from going bad. Then, actively communicate the company’s stance on fraud because creating awareness of workplace ethics helps prevent fraud.
6. Sixty percent of fraud cases are detected by a tip from an employee or by accident; not by an external or internal audit. Clearly, a reliance on luck is no basis for a strong anti-fraud regime. Because of this, the presence of a hotline in conjunction with a well-communicated and visible ethics campaign can act as a significant fraud deterrent. Also, develop policies to encourage, protect and reward employees for coming forward.
The earlier the crime is discovered the lower the risk of damage and the higher probability of recovering assets.
7. Ninety percent of asset misappropriation schemes involve cash. This is true for most industries, except the retail industry. Of course, who wants to worry about engaging in another step in committing fraud, by having to convert other assets into cash.
When people go fishing, they go where the fish are located. The same is true in detecting fraud. Approximately seventy-five percent of cash schemes are from fraudulent billing or internal check tampering.
A billing scheme usually involves an employee with the ability to approve invoices for payment. As a result, they will approve invoices they have created and sent in by mail. Usually the fraudulent invoices are for services such as consulting, which were never provided.
Internal check tampering involves an employee with access to the checks and the records of the company. Typically, the employee forge or alter checks from the company. The employee could also cause a duplicate payment to be made to a vendor and then will intercept the check.
Another key area in cash is cash receipts. The critical points to supervise involves the employee who first handles the receipts when then come into the company the last to handle the receipts before the deposit is made.
8. Identify and proactively monitor risky areas. Every business needs someone to identify the highest fraud risk areas and then develop ways to monitor those areas. Let’s stop reacting to fraud and start being proactive. When we proactively seek out fraud we are helping to prevent fraud by increasing the perception of detection. Frauds do not diminish, but grow over time so it is important detect fraudulent activity early. Proactively seeking out fraud is the most effective and efficient way to deal with fraud.
The justice system is ill-equipped to deal with fraud and, as a result, the private sector must step up and concentrate on prevention
9. Embezzlement is a special type of fraud. When someone embezzles at your company, you lose twice. Not only have you lost in a tangible way, financially, but you have also lost emotionally by suffering the loss of trust.
The tangible loss is bad enough, but the moral loss can be substantial and sometimes it can take years to repair these emotional losses after a long-time, trusted employee commits fraud.
10. Take action if you suspect fraud. Conducting a fraud investigation is a highly complex and specialized field. After suffering a tangible loss and an emotional loss, the last thing you want to do is lose a third time by not observing the legal the rights of employees.
When a bank is robbed everyone knows a crime has been committed, but does not know the person who robbed the bank. In alleged fraud we usually know who did it, but the question is was a crime committed? If the right evidence is not collected properly it will be hard to prove the employee intended to commit the fraud. Remember, fraud and stupid look the same.
Be prepared by devising a robust fraud response plan and start by contacting your attorney and Certified Fraud Examiner. Once a suspected fraud is authenticated, a response is mandatory to deter other potential fraudsters. Inconsistent response, such as treating executives different from employees, can cause a significant drop in moral and possibility of further problems.
