Occupational fraud and abuse

Enron, WorldCom, Adelphia, Martha Stewart … These cases may seem unusual and exceptional, at least in part because of the broad publicity and the extent of the frauds. However, they may be less extraordinary than they appear. Because of need, greed, egos and opportunity, fraud is pervasive, occurring daily to some extent at most organizations, and it affects all of us.

The term “occupational fraud” is defined as “The use of one’s occupation for personal enrichment through deliberate misuse or misapplication of the employing organization’s resources or assets.” There are three common types: Asset misappropriation (larceny, skimming); corruption (kickbacks, extortion); and fraudulent statements (financial statements, employment credentials).

According to the 2004 Report to the Nation on Occupational Fraud and Abuse, published by the Association of Certified Fraud Examiners, the typical organization loses about 6 percent of its revenue to occupational fraud and abuse. The report also concluded:

* Fraud is more likely to be detected by tips than by any other method.

* Confidential reporting mechanisms reduce the amount of loss per fraud incident by more than 50 percent.

* Median losses suffered from fraud are proportionately much greater in smaller organizations than in larger organizations.

* There is a direct correlation between the amount of fraud losses per occurrence and the perpetrators’ position, income level, tenure and education.

* The best way to deal with fraud is to prevent it.

The vast majority of reported frauds were asset misappropriations (median loss $90,000). Less than one-third were corruption (median loss $250,000), and less than 10 percent were fraudulent statements (median loss $1 million).

There are proven methods to reduce the incidence of fraud and the amount of loss resulting per incident, and to detect fraud occurring in your organization. Such methods are based on individual and system integrity and common sense, and are often most effective when focused on reducing opportunities and incentives while increasing the likelihood of detection and prosecution.

The following fraud prevention techniques apply to some degree to virtually all organizations.

* Detecting and prosecuting perpetrators of fraud increases others’ perceptions that they, too, could be caught, and they’ll be less likely to commit future fraud.

* Set the tone at the top.

* Create an environment in which employees, vendors, customers and suppliers believe that dishonest acts will be detected by management and the perpetrators will be prosecuted.

* Lead by example and display unquestionable integrity and commitment to ethical conduct.

* Have a written code of conduct, including specific responsibilities of management, to understand areas of exposure to fraud and for detecting and reporting suspected impropriety.

* Educate employees about the fraud prevention and detection implications in their areas of control.

* Monitor and confront suspected perpetrators.

* Create an anonymous fraud hotline where employees, suppliers and customers can report suspicious activity.

It’s also important to screen out those likely to commit fraud. Pre-employment screening should include a thorough check of credentials and references, and pre-employment background searches should include civil and criminal history, bankruptcy and other indications of financial hardship.

Post-employment, monitor personal situations, family, finances, affiliations, etc., and changes in habits, appearance and behavior.

You can reduce the opportunity for fraud to be committed and go undetected through internal control systems, monitoring and audit.

* Deny access and opportunity.

* Separate tasks (writing checks, accounts payable and bank reconciliations).

* Carefully select and periodically rotate personnel in high-risk exposure areas.

* Monitor and enforce control systems and procedural compliance.

Although you may not be able to completely prevent fraud, by implementing a comprehensive, thoughtful fraud prevention system, you can significantly reduce the frequency and amount of fraud losses. ROBERT GREENWALD, CPA, JD, CFE, ABV, is a director of business valuation and litigation consulting services at Saltz, Shamis & Goldfarb, the tax and accounting division of SS&G Financial Services Inc. Reach him at [email protected] or (440) 348-8787.