Word to the Wise: Uncovering Fraudsters at Work
Occupational fraud is a threat to all companies, but it’s especially disturbing when it occurs in closely held businesses. In many cases, employees are family members, and it’s difficult to believe that relatives would intentionally hurt the business.
Unfortunately, they may—and they can cause enormous damage.
According to the Association of Certified Fraud Examiners, the typical organization loses 5 percent of total annual revenues to fraud. While median losses are in the $130,000 range, more than one-fifth of cases incur losses of at least $1 million.
Not surprisingly, there is a strong correlation between the fraudster’s level of authority and the size of the fraud. Owners and executives committed only 19 percent of the frauds studied, but the losses incurred by their schemes were six times larger than the losses caused by managers and 17 times larger than the losses caused by low-level employees.
Frauds committed by high-level employees are often harder to detect and tend to last a long time—an average of two years. Executives are also more likely to collude with others, which tends to increase the damage caused. Interestingly, fraudster owners and executives also engaged in non-fraud-related misconduct more often, with bullying or intimidation the most common misbehaviors, observed in 41 percent of these cases.
Perpetrator tenure also impacts the damage done: Cases involving fraudsters who have worked at the company for 10+ years caused the highest median losses. Gender also makes a difference. The majority of fraudsters are men, and they cause much larger median losses than women do. As one might expect, losses tend to rise with the age and education level of the fraudster.
Employees who commit fraud often show troubling behaviors that the ACFE terms “red flags” of fraud. The following are the most common and consistent:
• Living beyond their means
• Financial difficulties
• Unusually close relationships with vendors or customers
• Control issues or unwillingness to share duties
• Divorce or family problems
• A “wheeler-dealer” attitude
Fraudsters often also exhibit human resources-related red flags such as poor performance evaluations, loss of pay or benefits, or fear of job loss. In fact, 39 percent of fraudsters experienced some form of HR-related red flags before or during the time of their frauds.
However, the vast majority of fraudsters have no prior criminal history—only 4 percent had previously been convicted of a criminal offense.
Proactive prevention and detection are key to deterring fraud. While the presence of anti-fraud controls of any sort correlates with lower losses, the most effective are the use of proactive data monitoring and analysis and surprise audits, both of which reduce damage and duration of fraud.
Tips, internal audits, and management reviews are the leading detection methods. In this year’s study, slightly more than half of tips came from employees, with nearly a third coming from customers, vendors, and competitors. One of the most effective ways to gather tips is via an anonymous hotline. Fraud losses are 50 percent smaller at organizations with hotlines than those without.
Facing the reality of fraud is unpleasant, but losing your hard-earned assets to a trusted employee is even worse. A fraud assessment and an internal controls study are good ways to get started to deter and detect occupational fraud.