While high-profile cases such as Tyco, WorldCom and Enron garner the headlines, companies of all sizes can be affected by corporate fraud. The types of schemes used to misappropriate funds vary in nature but are similar in the fact that they can be extremely costly.
“The Association of Certified Fraud Examiners estimates that the typical organization loses approximately 5 percent of its annual revenue to fraud,” says Kevin Yardumian, vice president of Gumbiner Savett Inc.
Smart Business spoke with Yardumian about corporate fraud and how to go about implementing fraud controls.
What types of corporate fraud are most prevalent?
There are two basic types of corporate fraud we come across quite frequently: financial statement fraud, which involves the misstatement of financial information by the company’s management, and asset misappropriation schemes, which involve an employee using his or her position within a company to misappropriate company assets or resources. While both types of fraud can have a devastating effect on an organization, asset misappropriation is more common.
Some asset misappropriation schemes that we’ve seen include:
- The establishment of a shell company, which submits fraudulent invoices to the victim company. The invoices may be for nonexistent shipments or services or may reflect inflated amounts for legitimate shipments or services provided by a third party that have been diverted through the shell company. This type of fraud is particularly common in companies that purchase goods or services overseas.
- Shipments of inventory to unauthorized recipients. This is very common among companies that don’t have accurate perpetual inventory systems but instead rely on periodic physical counts.
- Check tampering and forged endorsement schemes
- Payroll fraud involving fictitious employees
- Employee kickbacks
- Diversion of cash receipts
- Fraudulent commission schemes
In addition to financial losses, what types of collateral damage can a company sustain?
The majority of employee-related fraud involving publicly held companies is never prosecuted because of the impact that public knowledge of the fraud could have on public confidence in the company and the company’s stock price. For private companies, knowledge of fraud can diminish a lender’s confidence in the company’s management. It may also encourage additional fraud due to the perceived lack of controls in place to detect and defer fraud.
How should a business go about implementing fraud controls?
When working with business owners to establish an anti-fraud program within their organization, we typically go through a four-step process. First, we help the business owner understand some of the fraud schemes that are most common for his or her particular type of business, which we base on factors such as the industry and company size. Secondly, we identify the assets within the organization that are susceptible to fraud. Next, we develop and implement a system of controls to detect and deter fraud within the organization and to safeguard the assets susceptible to fraud. Finally, we establish a program for monitoring compliance with the system of controls and for updating the controls as necessary.
How important is it to have open avenues of communication for employees who suspect foul play?
Very important. While every organization should have a system of controls in place designed specifically for that organization, having an open line of communication with employees is something that is important for all organizations because it helps establish an anti-fraud culture. Some of the basic steps an organization can take to establish an anti-fraud culture include:
- Providing anti-fraud training to employees that focuses on identifying warning signs of fraud
- Establishing an ethics officer within the organization who meets regularly with employees
- Developing a corporate code of conduct that spells out acceptable versus unacceptable behavior and specifies penalties for violations
- Establishing a mechanism for fraud to be reported by employees on an anonymous basis, such as a whistle-blower or fraud hot line
If a company suspects that fraud has occurred, what steps should be taken?
If a company suspects that fraud has occurred, it should contact an anti-fraud professional to assess the damages and to implement controls to prevent additional losses. There is very powerful technology available to assist with this process. That being said, the best time for a business owner to contact an anti-fraud professional is before he or she suspects fraud.
The majority of our fraud-related work is related to implementing controls prior to the suspected occurrence of fraud, in essence, a preventive maintenance engagement. Although sometimes when we perform this type of engagement we find that fraud actually has occurred, it just wasn’t previously suspected or detected.
KEVIN YARDUMIAN is a vice president of Gumbiner Savett Inc. He is a certified fraud examiner as well as a CPA and works closely with business owners to minimize their exposure to fraud. Reach him at (310) 828-9798 or email@example.com.