Greed and the breakdown of internal controls have led to a global economic panic, and fraud is suspected to be behind a large portion of it. Fraud can be perpetrated not only by internal employees but also by customers and vendors, says Ian Waller, a partner at Nichols Cauley & Associates.
“Fraud is more likely to occur when employees and companies are feeling outside financial pressures,” says Waller. “In these uncertain economic times, companies are forced to do more with less, providing opportunity. And as conditions worsen, employees and companies rationalize cheating.”
Smart Business spoke with Waller about the cost of fraud and how to lower the risk of it occurring at your company.
How prevalent is fraud?
According to the Association of Certified Fraud Examiners, the typical organization loses 5 percent of its annual revenue to fraud, a potential loss of more than $2.9 trillion.
Asset misappropriation schemes were the most common form of fraud, accounting for 90 percent of cases, although they were the least costly, with a median loss of $135,000. Financial statement fraud schemes, while they made up less than 5 percent of the frauds, caused a median loss of more than $4 million.
Who is at risk for fraud?
Small organizations are disproportionately victimized by occupational fraud because they are typically lacking in anti-fraud controls, compared to their larger counterparts.
The industries most commonly victimized were banking/financial services, manufacturing and government/public administration sectors. In addition, more than 80 percent of fraud in studies was committed by individuals in accounting, operations, sales, executive/upper management, customer service or purchasing.
Studies show the typical fraudster is a middle-aged male in a senior management role related to the finance function of an organization. Other high-fraud areas involve the operations and sales departments.
Most fraudsters have worked for the organization for more than 10 years and are generally in collusion with another individual. The individual is likely to have gained trust and respect from colleagues and has identified weak controls and opportunities to exploit the business. Individuals faced with changes in personal circumstances or pressures to meet difficult work targets may also turn to fraud. Look for red flags including an employee living beyond his or her means or showing control issues.
Fraud typically occurs when pressure/incentive, opportunity and rationalization come together, and organizations and individuals that know the common characteristics of a fraudster are better prepared to detect and prevent damaging incidents.
What is occupational fraud?
Schemes can be as simple as stealing supplies or manipulation of timesheets, or as complex as sophisticated financial statement frauds. There are three primary categories.
- Asset misappropriations, in which the perpetrator steals or misuses resources, including skimming cash receipts, falsifying expense reports and forging company checks.
- Corruption schemes, which involve the employee’s use of influence in business transactions in a way that violates a duty to the employer in order to obtain a benefit for the employee or someone else. Examples include bribery, extortion and a conflict of interest.
- Financial statement fraud schemes involve the intentional misstatement or omission of material information in the organization’s financial reports. Common methods include recording fictitious revenue, concealing liabilities or expenses, and artificially inflating reported assets.
Are there other areas in which businesses face the risk of fraud?
Another risk is vendor fraud, including fraudsters who create fictitious companies and submit bills for payment, and trusted suppliers who charge you more than they are due. Vendors may even collude with your employees to help them navigate your company’s internal controls.
Common types of vendor fraud include:
- Vendor masking, in which companies hide their real identity, making it harder to detect fraudulent activity and recover lost funds.
- Inside jobs, in which current or former employees with knowledge of your internal controls commit fraud.
- Flying under the radar, in which criminals avoid detection by using practiced techniques for blending in with legitimate invoices, vendors and payments.
- Organized crime billing schemes, in which criminals take a planned and organized approach to defrauding your company.
How can businesses protect themselves?
Staff members are an organization’s top fraud detection method, and employees must be trained in what constitutes fraud, how it hurts everyone in the company and how to report questionable activity.
Audits can have a strong preventive effect on fraudulent behavior, but should not be relied upon exclusively. While surprise audits can be useful, their most important benefit is creating a perception of detection. The threat of surprise audits increases employees’ perception that fraud will be detected and thus has a strong deterrent effect.
Advances in IT and computers better enable fraud. Companies are doing more with less, creating risks. Simple tools such as employee education and implementation of the perception of detection are cost-effective ways to limit fraudulent occurrences.
Ian Waller is a partner at Nichols Cauley & Associates. Reach him at (404) 214-1301 or firstname.lastname@example.org.