Most every organization has assets, and every bit of those assets is valuable. It’s why every organization is at risk of becoming a target for occupational fraud.
Occupational fraud is 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."1 In other words, individuals use their positions to find and exploit weaknesses in an organization’s controls in order to profit in some way.
Also referred to as workplace fraud or simply asset theft, occupational fraud is a daily risk and an expensive problem. The Association of Certified Fraud Examiners (ACFE) estimates that the typical organization loses 5% of revenues annually as a result of fraud. In 2016, total losses caused by the cases studied exceeded $6.3 billion, with an average loss per case of $2.7 million.
Given the enormity of the risk and costs and the prevalence of its occurrence, how fraud savvy do you believe you are? Could you identify fraud by way of suspicious behavior? How much do you know about the circumstances surrounding fraudulent activity?
Let’s start by taking this short quiz to determine whether you can outsmart a fraudster.
- True or False: Most fraud perpetrators are career criminals, and conducting background checks will weed them out.
- There is a set of circumstances that, when combined, can lead individuals to commit fraud in the workplace. These circumstances are known as the “fraud triangle” and include the pressure to commit fraud, the opportunity to commit fraud, and the ____________ for committing the fraud.
- Which of these weaknesses allowed the most frauds to occur in 2016?
- The victim organizations had no employee fraud education.
- There was poor tone from leaders at the top.
- Fraudsters had the ability to override existing internal controls.
- There was a lack of internal controls altogether.
- Which of the following was the most common method fraudsters used to conceal their schemes?
- They altered or created physical documents.
- They altered or created fraudulent transactions in the accounting system.
- They destroyed physical documents.
- They altered or created fraudulent electronic documents or files.
- Below are some fictional employee profiles. Which employee might be displaying the warning signs associated with fraud?
- Donna is a 17-year employee who manages the company’s accounting department. Always hardworking, she is forthright in her dedication to the company, so much so that she refuses to take time off. In fact, no one can remember her ever taking a vacation. Donna typically will not delegate duties, preferring to do it all herself. She recently went through a stressful divorce, and because of her workaholic nature, she doesn’t have much of a social life outside of work.
- Joe is a top-performing purchasing agent for the company. He’s done an outstanding job and has great relationships with vendors, especially Vendor X. The two are unusually close, talking and emailing daily and taking lunches weekly. Last month, Joe vacationed in the Bahamas like he did last year. This year he says he made a condo investment while he was there, and just this month he arrived at work in a brand new luxury car.
- Paul is the COO of the company and has a rather large ego. He believes he’s underappreciated and has never quite gotten over the fact that he was passed over for the CEO position. He works diligently and gives generously to every charitable cause the company supports. Yet all the executive admin assistants know that he regularly pads his expense reports, often putting personal items on the corporate credit card.
- False. The vast majority of perpetrators are first-time offenders. In fact, the latest study shows that 88% have no history of fraudulent charges or convictions.
- Rationalization. This is a frame of mind that justifies wrongdoing. It’s the ability fraudsters have to convince themselves that what they’re doing is actually okay. Among the potential rationalizations for committing fraud are:
- I’m now doing the work of two people (for survivors of downsizing or layoffs), so I deserve this.
- I’m now doing my old job for a reduced pay rate (for those working with mandatory pay reductions), so the company owes me.
- It’s just short term; I’ll pay it back as soon as things improve.
- Everyone else is doing it.
- The company will never miss it.
- d. Nearly 30% of victimized companies cited a clear lack of internal controls as the primary issue contributing to the fraudster’s ability to perpetrate a scheme!
- a. No matter the type of fraud perpetrated, fraudsters most often altered or created physical documents to conceal their misdeeds. That type of concealment was followed right down the line by “b,” “c,” and “d” as other methods most frequently used.
- All of them. According to the ACFE study, 79% of perpetrators display some kind of behavioral warning signs. While such red flags can indicate fraud, they are not absolute assurances. The most common red flags are:
- Living beyond means.
- Financial difficulties.
- Unusually close association with a vendor or customer.
- Excessive control issues; unwillingness to share duties.
- Recent divorce or family problems.
- A general “wheeler dealer” attitude involving unscrupulous behavior.
Identifying Red Flags
In 92% of fraud cases reviewed, at least one common behavioral red flag was identified. In 64% of cases, two or more red flags were identified.
To reduce or avoid losses, organizations should learn to recognize a few warning signs. These red flags can be categorized into situational, opportunity, and characteristic variables or influences that can potentially result in fraud.
Situational red flags include employees with high personal debts or losses, those living beyond their means, and individuals with gambling, alcohol, or drug abuse problems. Such situations can present a strong motivation to steal. Indeed, a great many fraud cases are committed in order to meet personal financial obligations, particularly ones that have spiraled out of control.
Opportunity presents another temptation. Often, small businesses invest far too much trust in key individuals without instituting the necessary balance of controls. Opportunity red flags can include dominant employees who are intimately familiar with operations and those with close supplier or vendor associations.
Lastly, character traits can also serve as red flags. Studies have shown that employees who engage in workplace abuse such as excessive absenteeism, pilfering, and goldbricking are at higher risk for committing fraud.
All Kinds of People
Clearly fraudsters have many faces and backgrounds, and there’s no such thing as a typical perpetrator. Despite the wide variety of traits and behaviors, there are genuine patterns and authentic trends that can help organizations become more aware of and responsive to fraud.
Consider these profile facts uncovered by the recent ACFE report:
- Fraudsters are more than twice as likely to be male than female. In addition, losses attributed to males were 123% higher than losses caused by females.
- Nearly half of perpetrators had a college degree.
- Seventy-seven percent of all occupational frauds originated in one of seven organizational departments: accounting, operations, sales, executive/upper management, customer service, purchasing, and finance.
- The majority of frauds are committed by staff at the employee or managerial level. However, the higher the fraudster’s position of authority, the greater the losses. ACFE surmises that’s because executives have greater access to assets and a better ability to evade or override antifraud controls.
- Fifty-two percent of fraudsters are between 31 and 45 years old, but older fraudsters tended to cause greater losses.
- Only 7% of perpetrators committed fraud during their first year on the job. In contrast, 53% had been with their organizations for more than five years. In addition, the longer a fraudster had worked for a company, the more harm (losses) he or she was likely to cause.
To sum up, your biggest risk is from employees who are longer tenured, more experienced, better educated, and more trusted. Just the kinds of employees you want and value! It’s easy to see why spotting and preventing fraud is such a difficult and ongoing challenge.
All Kinds of Schemes
Occupational fraud is typically classified into three categories: asset misappropriation (embezzlement, theft of cash or other assets, false expense reports, forgery, check tampering, billing schemes), corruption (conflict of interest, bribery, extortion), and financial statement fraud (fictitious revenues, inflating assets, concealing or underreporting expenses or liabilities).
Among the three categories, asset misappropriation is most prevalent, representing 83% of fraud cases reported in 2016. The median loss for victim organizations in these cases was $125,000. In contrast, fewer than 10% of cases involved financial statement fraud, but such cases had the greatest financial impact, with a median loss of $975,000.
There’s no doubt that occupational fraud schemes are extremely costly. Overall, the median loss reported in the most recent ACFE study was $150,000. Just under one-quarter involved losses of $1 million or more.
Since fraud schemes frequently continue for years before they are detected, such losses have a way of adding up. The median duration of the frauds committed was 18 months, with nearly a third of them lasting two years before they were detected.
Some common examples of fraud schemes across various departments include:
Travel and Entertainment
- Double dipping. Submitting the same expense for reimbursement more than one time.
- Unauthorized expenses. Obtaining reimbursement for expenses not allowed under company policy.
- Bait and switch. Getting preapproval for one type of expense but then purchasing a different and less expensive item and receiving the higher, preauthorized amount.
- Conflicts of interest. The person purchasing items has a conflict of interest in which judgment may be compromised, such as an ownership interest in the vendor or being related to a vendor owner or a vendor’s employees.
- Collusion. Instances such as bid rigging, kickbacks, or purchasing inferior products, in which a person inside the organization works in concert with someone outside the organization and steers business to a particular vendor. (The larger the group of colluders involved in a fraud scheme, the greater the damage.)
- Ghost employees. Individuals who don’t really exist get hired and paid (usually the pay goes to the supervisor responsible for hiring and approving pay).
- Hours/pay schemes. Employees, with or without the assistance of supervisors, submit time not worked or time coded at higher-paid duties than were actually worked.
- Fictitious vendor. Creating and processing payments to a vendor that doesn’t exist for goods or services never received.
- Check tampering. Includes check forgery, altering payees, or forging the endorsement of checks payable to a legitimate vendor.
Start to Outsmart Fraud With Smart Internal Controls
Clearly, having a fraud prevention program and proper internal controls is vital, as the ACFE report bears out. When fraud was uncovered through active detection methods such as surveillance and monitoring or account reconciliation, the median loss and median duration of the schemes were lower than when the schemes were detected through passive methods such as notification by police or accidental discovery.
And yet smaller organizations continue to have significantly lower implementation rates of antifraud controls than large organizations. This gap in fraud prevention and detection leaves small organizations (those with under 100 employees) extremely susceptible to fraud that can cause devastating damage to their limited resources.
Fraud risk management requires several fundamental factors, the first of which is having proper internal controls. Among them are:
- Robust internal control environments
- Conducting risk assessments
- Instituting control activities like policies and procedures, segregation of duties, and surprise internal and external audits, for example
- Ensuring ongoing employee training
- Monitoring and acting with a response plan
These are just the building blocks for developing an effective antifraud strategy. Recognize the harsh reality that fighting fraud is difficult and time consuming but necessary. Get expert help with extra vigilance and targeted strategies whenever you need it.
12016 Association of Certified Fraud Examiners, Inc., Report to the Nations