The cost of corporate fraud


Corporate fraud is not limited to high-profile cases like Enron, Tyco and WorldCom. According to the Pricewaterhouse Cooper Global Economic Crime Survey 2005, 45 percent of 3,634 companies reported being subject to one or more significant economic crimes during the previous two years. This reflects an eight percent jump over the same 2003 study.

To turn the tide, it is important for companies to institute fraud prevention programs that combine thorough auditing procedures with open avenues of communication for employees who suspect foul play.

“People who know that someone’s watching have to think a little harder about committing a fraud than when it’s wide open and there are no deterrents in place,” says Karin Heckman Nelson, a partner at Vicenti, Lloyd & Stutzman LLP accountants. “If you know that nobody is going to do anything, it gives you an opportunity — which is one of the things that you need in order to commit a fraud.”

Smart Business spoke with Nelson about the average financial loss of a company that has been defrauded, the types of collateral damage that can be sustained, and how to best implement fraud controls.

Why is fraud becoming so prevalent?
It’s hard to know if it’s becoming more prevalent or if today’s environment is actually encouraging more reporting of fraud. There has been increased attention to fraud with the recent large, publicized fraud cases. Also, the Sarbanes-Oxley Act has placed more emphasis on corporate governance and regulations. These factors may lead to more actual reporting of fraud rather than fraud going undetected.

What types of companies are most at risk, and what types of fraud are most common?
Organizations that process large amounts of cash are at greatest risk. Those would include financial institutions and retailers. However, there is risk in all companies and across all sectors, including governmental entities and nonprofit organizations.

As far as types of frauds, you have cash skimming where a lot of cash is handled and a person deposits some of it and keeps a portion for their own pocket. There are payroll schemes, which involve setting up fictitious employees and then having checks written in that person’s name, which are then deposited in the perpetrator’s account. It’s also possible to set up fake companies like Enron did. There are all kinds of possibilities.

What is the typical financial loss for a company that has been defrauded?
According to the 2004 Report to the Nation on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners, the median loss to small businesses was $98,000. The typical organization loses six percent of its annual revenue to occupational fraud.

In addition to economic losses, what types of collateral damage can a business incur?
There are other less tangible losses, which can include damage to a company’s reputation — both with the public and with its employees. Fraud can also lead to reduced employee morale and open the doors to more deception: if an employee sees somebody else getting away with something they may say ‘Oh, that was easy,’ and try it themselves.

How can businesses implement fraud controls to protect their assets?
One of the most effective ways to limit fraud losses is to have an anonymous reporting mechanism such as a fraud hotline. The surveys have found that the most common way for fraud to be discovered is through tips. Employees are less willing to steal if they know that controls are in place to protect against theft. It’s important to have strong internal controls set up that both would deter someone and detect if a fraud has occurred. Internal and external audits can also be an important tool.

If a company suspects that fraud has occurred, what steps should it take to stem the situation?
First, it needs to investigate the allegation. The company can either assign captive employees or find someone outside the organization. If the claim is then substantiated, the company needs to take appropriate action such as termination and prosecution. These actions are important because they demonstrate that the company is not tolerant of fraud – which can discourage the next employee from taking such actions.

KARIN HECKMAN NELSON is a partner at accounting firm Vicenti, Lloyd & Stutzman LLP. Reach her at (626) 857-7300 or [email protected].