Occupational fraud is an equal opportunity offender, occurring in any organization regardless of size or industry. Sometimes referred to as workplace fraud or asset theft, occupational fraud is more properly defined as “the use of one’s occupation for personal gain through the deliberate misuse or theft of the employing organization’s resources or assets.”
In simplest terms, it’s the full range of willful employee misconduct through which a business loses money. How much money? The most recent estimates from the 2016 Association of Certified Fraud Examiners’ Report to the Nations are staggering. The total loss caused by the cases in its study exceeded $6.3 billion. The median loss for all cases in the study was $150,000, with almost a quarter of cases reporting losses of $1 million or more.
The study further breaks down the various fraudulent activities and their accompanying losses:
- Asset misappropriation (theft of cash, false expense reports, equipment, inventory) was the most common form of occupational fraud, occurring in more than 83% of cases but causing the smallest median loss of $125,000.
- Financial statement fraud (fictitious revenues, inflating assets, concealing or underreporting expenses or liabilities) was on the other end of the spectrum, occurring in less than 10% of cases but causing a median loss of $975,000.
- Corruption cases (conflict of interest, bribery, extortion) fell in the middle, with 35.4% of cases and a median loss of $200,000.
The first reaction is to attribute the bulk of fraudulent cases to mostly frontline employees who might steal cash and other assets. However, the report clearly puts that misconception to rest. In fact, more occupational frauds originated in the accounting department (16.6%) than in any other business unit. In addition, of all the frauds analyzed in the report, more than three-fourths were committed by individuals working in seven key departments: accounting, operations, sales, executive/upper management, customer service, purchasing, and finance.
What’s more, the perpetrator’s level of authority was strongly correlated with the size of the fraud. The median loss in a scheme committed by an owner/executive was $703,000. This was more than four times higher than the median loss caused by managers ($173,000) and nearly 11 times higher than the loss caused by employees ($65,000).
In addition, approximately 88% of the individuals caught in fraudulent activities had no prior criminal record.
So why do employees do it? The reasons can be found within the Fraud Triangle.
The Three Elements of the Fraud Triangle
The Fraud Triangle is a model for explaining the “perfect storm” factors that cause someone to commit fraud. It consists of three components that together lead more employees to commit fraud. They are financial pressure, opportunity, and rationalization.
It’s not hard to see how financial pressures can come into play. Uncontrolled spending habits, credit card debt, gambling addiction, and costly divorces all create economic pressure. Employees facing such pressures may begin to look for ways to commit fraud.
Opportunities to commit fraud occur when employees have access to assets and information that allows them to both commit and conceal fraud. In other words, without internal controls, or checks and balances, they have the ability to do something wrong.
The third side of the fraud triangle is rationalizing inappropriate behavior and workplace misconduct. This one’s not hard to imagine either. If an employee believes he or she is doing the work of two people or is asked to take on additional responsibilities without increased pay, that employee could begin rationalizing ways to take “rewards” illegally. Often employees rationalize their misdeeds as simply short-term loans they tell themselves they’ll pay back as soon as their situation improves.
It’s important for organizations to recognize and address these risks. Fraud perpetrators tend to display behavioral warning signs in the period leading up to and when they’re actively engaged in their crimes. The most common red flags are living beyond means, financial difficulties, unusually close associations with a vendor or customer, excessive control issues, and recent divorce or family problems. At least one of these red flags was exhibited in 78.9% of the fraud cases in the 2016 report.
Importance of Internal Controls
The most prominent organizational weakness that contributed to the frauds in the study was a lack of internal controls. Not surprisingly, small organizations had a significantly lower implementation rate of antifraud controls than large organizations, according to the study. This gap in fraud prevention and detection coverage leaves small organizations extremely susceptible to frauds that can cause significant damage to their limited resources.
Among the internal controls that are necessary are:
- The need for effective control environments.
- The need to conduct risk assessments.
- The need to institute control activities like policies and procedures, segregation of duties, meaningful management reviews, and surprise internal and external audits, for example.
- The need to ensure ongoing employee training.
- The need to monitor and act with a response plan.
One simple measure that has been proven effective against fighting fraud, time and again, is a hotline. Not only is it the most common detection method (39.1% of cases), but organizations that had reporting hotlines were much more likely to detect fraud through tips than organizations without hotlines (47.3% compared to 28.2%, respectively).
Recognize the Risks and Realities
Awareness that your organization is at risk is the first and most important step in meeting the issue head on, before your organization becomes a victim. The key is to identify what your organization’s risks are, where they exist, and what tool(s) can help mitigate those risks most effectively and efficiently.
Perhaps equally important is the need to recognize the harsh reality that fighting fraud is difficult and time-consuming but necessary. Get expert help with extra vigilance and targeted strategies whenever needed.
2016 Association of Certified Fraud Examiners, Inc. Report to the Nations.