Although business owners often take steps to mitigate potential theft from outsiders, they are often reluctant to address the risk of fraud committed by their own employees.
Although employers inherently trust their employees, the smart business owner should still take steps to reduce the opportunities for fraud to occur, says Clark Keeler, CFE, director, Assurance & Consulting at Burr Pilger Mayer, Inc.
“Fraud risk is always present. If you don’t address that risk, all you can hope for is that you are lucky,” Keeler says. “The average loss in a fraud occurrence is $160,000. That is a lot of expense to leave to luck.”
Smart Business spoke with Keeler about minimizing the risk of occupational fraud.
Why should employers be concerned about the risk of fraud?
Occupational fraud occurs when an employee or vendor finds a way to divert assets from a company by means of deception. The ACFE’s 2010 Report to the Nations estimates that 5 percent of the annual revenues of companies worldwide is lost to fraud, approximately $2.9 trillion! And that estimate cannot factor in the frauds that are never uncovered.
All organizations need to be concerned with fraud, because the risk is always present and because management doesn’t control the factors that can get someone to commit fraud. Management should understand that it takes, on average, 18 months to discover fraud. So, not only are the economic damages enormous, but the fraud can also seriously damage trust within the corporate culture. Employees may no longer feel certain they can trust their peers, and management may no longer feel safe trusting employees. The cultural damage can take a long time to recover from.
How is fraud commonly discovered?
In more than 40 percent of cases, fraud is discovered as the result of a tip from a third party. Although companies tend to rely on their external auditors, statistically external auditors discover less than 5 percent of fraud cases. Management review (16 percent) and internal audits (14 percent) are more effective that external audits.
How can employers prevent fraud?
Fraud can never be completely prevented. Management can be diligent and implement practices that reduce its impact. For fraud to occur there has to be opportunity, a perceived need and the ability to rationalize the behavior. The needs may be real (medical bills for a sick child), or imagined (a desire for a second home), but the rationalization will be made to justify that need. Unfortunately, management can’t control what employees think. However, they can reduce the opportunity to commit fraud by implementing internal controls that make it difficult for a single individual to carry out the fraud. The primary goals of internal controls are to reduce opportunity and to allow timely reaction to the indicators of fraud.
It is also important for management to create and maintain an ethical environment that communicates an ethical tone from the top, and communicates that fraud won’t be tolerated. Communication and trust between management and employees is critical. The implementation of an anonymous reporting hotline that allows employees to report suspected fraud can be very effective.
What other steps can employers take?
Almost all fraud prevention strategies relate to oversight. Where possible, management should try to create a segregation of duties so that no one individual has control over critical information that isn’t reviewed. You don’t want the individual who pays the bills also determining who your company does business with. Have another individual involved in the process wherever possible.
When an employee has no oversight, it doesn’t take that person long to realize it, and the fraud factors — opportunity, need and rationalization — have a chance to fester. Most people are ethical and won’t give in to the temptation that opportunity provides. However, management doesn’t need to take that chance. Take away the opportunity and the perception of need and rationalization may never arise.
In smaller companies, it’s often difficult to create a segregation of duties. However, there are ways to monitor information relating to an individual’s activities. If management can’t review a person’s work while it is happening, they can always monitor the results in a timely fashion after the fact.
How can employees play a role in fraud prevention?
Get employees to feel part of the organization. Employees provide the best fraud protection a company can have. Employee education is the foundation of preventing and detecting fraud. If your employees are aligned with the company’s goals, they will keep one another in line and won’t tolerate misbehavior. They’ll believe misbehavior impacts them. However, if employees don’t feel aligned with management and the business, they may turn a blind eye, or commit fraud themselves.
How can a forensic expert help employers address fraud?
In a preventive situation, a forensic expert will assist management in strengthening and documenting the ethical environment they’ve created, and assist them on how to communicate those beliefs to employees. Simultaneously, the forensic expert will identify and address the weak points in the company’s internal controls so that the opportunities for fraud are minimized.
Once fraud has occurred, there are no positive scenarios. Management has already lost the money, and the chances of recovery are small. Investment in a forensic team to determine how the fraud occurred incurs even more costs. It is always much easier, and far less expensive, to invest in a little protection up front by proactively implementing the preventive fraud practices that reduce the always-present risks of fraud.
Clark Keeler, CFE, is director, Assurance & Consulting at Burr Pilger Mayer. Reach him at (415) 863-3868 or CKeeler@bpmcpa.com.