No matter how well-run your company may be, or how close-knit your employees are, no company is immune to fraud. Corporate fraud, misappropriation of assets and financial statement abuse are not new problems, but they still need to be closely monitored.
“Managers of companies that experience fraud are often shocked to learn the fraud was perpetrated by a trusted employee of the business,” says Adam Wadecki, manager of operations, Cendrowski Corporate Advisors LLC. “It’s important to ensure safeguards are in place protecting the firm’s assets and reputation, irrespective of the level of confidence and trust managers may have in employees.”
Smart Business spoke with Wadecki about fraud, the impact it can have on an organization and what steps organizations can take to prevent it.
What impact can fraud have on an organization?
In its latest Report to the Nation, a document summarizing results and presenting conclusions from distributed surveys, the Association of Certified Fraud Examiners (ACFE) estimates that U.S. organizations lose 7 percent of their annual revenue to fraud. When applied to U.S. GDP, this figure represents nearly $1 trillion in fraud losses.
The ACFE also found that the median loss due to an incidence of fraud is roughly $175,000 and that the most commonly cited factor that permitted fraud to occur was a lack of adequate internal controls. However, these figures may underestimate actual fraud losses. Many companies that experience fraud are reticent to disclose facts about the incident, fearing that their reputation will be damaged if customers and suppliers learn a fraud was committed at their organization.
What characteristics define a fraudster?
Less than 10 percent of fraud perpetrators have prior criminal convictions; those who commit fraud are largely first-time offenders, even though the average fraud perpetrator is older than 40 years of age. Additionally, fraudsters generally exhibit one of two behavioral traits: They either live beyond their apparent means, or they are experiencing financial difficulties. They may also be trusted employees of an organization.
Many organizational managers are taken aback when they learn a long-time, trusted employee has committed fraud. It’s an unfortunately common event that few organizations prepared for or even envisioned. However, one often-forgotten characteristic all fraudsters possess is humanity. It’s important to remember that individuals who commit fraud aren’t necessarily bad people. Even the most honest person can turn to fraud if, for instance, he cannot afford treatments for his wife’s terminal illness.
For these reasons, and numerous others, it’s important for firms to have internal controls in place that preclude the opportunity for fraud, minimizing this causal factor so that the risk of fraud is significantly decreased.
Where within an organization is fraud more likely to occur?
Fraud will most likely occur in organizations where highly people-oriented processes are used to control the flow of funds, especially cash, and also monitor the flow of funds. While people are the key element of any organization, it’s essential that organizations not overlook the ‘humanness’ of employees and provide them with unfair temptation.
While we may not view it as such, almost all of us break the law multiple times during the day especially if we’re commuting into Chicago from the suburbs. Speeding is illegal. However, many of us commit this act frequently because 1) we’re often pressed for time (motive); 2) most cars are powerful enough to break the speed limit (opportunity); and 3) we feel it’s justified and the perceived penalty is low (rationalization). If, however, our cars were electronically programmed not to exceed the speed limit, the ability to break the law would not exist.
In much the same manner, it’s essential that organizations remove the opportunity for fraud from people-oriented processes to ensure that frauds cannot occur.
Are frauds typically committed at higher levels of the organization, or at the employee level?
Interestingly, though the frequency of fraud decreases as one progresses up the organizational ranks, the median loss of frauds grows significantly the higher the fraud occurs. For instance, roughly one-third of all frauds are committed by nonmanagerial employees, but the median loss for such frauds is less than $100,000. On the other hand, frauds committed by executives and owners are much less frequent, but the median loss for such frauds at that level is nearly $1 million.
Many firms concentrate on fraud controls at the employee level, but it’s also important to concentrate on the executive level. For example, we recently were engaged on a case in which a rental company had stringent controls on the rent collection process, making it very difficult for employees to commit fraud. What the company didn’t realize, however, was that the CFO was taking money out the back door because he had the power to override fraud-related controls and did so at his leisure.
How can organizations safeguard their assets against fraud?
The best way to guard against fraud is by assessing areas of vulnerability at all hierarchical levels of the organization through a comprehensive operational assessment. Such an assessment will examine the key processes in place throughout the organization, potential risks within each process and mitigating factors designed to minimize these risks.
By examining each of these elements, an operational assessment can help senior managers not only understand which areas are susceptible to fraud but can facilitate a discussion centered on re-engineering vulnerable processes to minimize the opportunity for fraud, as well as on the development of new mitigating factors to minimize risk.