Corporate fraud is a common and costly problem. It ranges from the employee who takes office supplies or pilfers from inventory to the high-level executive who creates phony accounts to siphon money from the company coffers.
The costs can be staggering, with the typical organization losing 5 percent of its revenues to fraud each year, according to the Association of Certified Fraud Examiners (ACFE).
Protect Against Fraud By Starting With Key Internal Policies
The best defense against fraud, however, lies in the adoption of some straightforward and low-tech measures. The first step is putting in place key internal policies and controls that reduce the opportunity for fraud. The second is creating a culture where employees are not only taught how to spot fraud, but also given a safe way to report potential abuses. To do both effectively, companies need to understand who is likely to commit fraud, how it happens and the most effective way of detecting it.
In most cases, for example, people committing the fraud are first-time offenders with clean employment records. According to a recent ACFE study, 87 percent of fraudsters had never previously been charged or convicted of a fraud-related offense. Typically, those who commit fraud are people facing personal or financial pressure who see an opportunity and are able to rationalize their behavior. While companies can’t control the personal problems of their employees, they can focus on limiting the opportunity and quickly identifying fraud when it happens.
Employee Training is Imperative To Exposing Fraud
Fraud is most commonly reported by employees who notice something odd and are willing to speak up. That’s a good reason why it pays to not only provide employees with a good fraud-prevention education, but also create safe ways for reporting fraud, such as a tip hotline.
Establishing a clear code of conduct that includes an explanation of employee expectations is a good place to start. Management needs to set the tone, both by example and by making the message clear. After all, it’s not just the company that will suffer if fraud goes undetected. In 20 percent of fraud cases, the damage can run $1 million or more. That means unchecked fraud can put a company out of business, irreparably harm the reputation of a company and ultimately cost people their jobs.
Smaller businesses are most vulnerable to fraud and typically suffer the largest median losses. In part, that’s because these organizations often lack the internal controls employed by big corporations. Those sectors most likely to be victimized include banking and financial services, government and public administration and the manufacturing sector.
Companies should let their employees know how to spot fraudulent activities. Those working in the financial area will want to look for transactions that have no apparent business purpose, undocumented travel expenses or a change in requests for funding. Such fraudulent financial reporting can be easy to spot if the fraudster isn’t sophisticated, but without the appropriate controls in place it can be less visible.
It’s often easier to recognize the personal red flags that are commonly exhibited by those pilfering the company. These might include someone living beyond their means, like driving an expensive car or buying items normally outside their budget. Other red flag indicators include addiction problems, divorce, financial difficulties or on-the-job defensiveness. Other signs that might seem more benign include refusing to take a vacation, a particularly close relationship with a customer or vendor, and even dedication to work that makes it difficult for others to share duties.
Review Your Internal Controls
Good internal controls are an effective way of limiting opportunity. Segregation of duties within the financial reporting process, for example, makes it tough for people to cut checks to fictitious vendors or funnel funds to phony expense categories. Management also needs an open door policy that encourages employees to not only notice potential fraud, but also to report it without repercussion. Since employees are the first line of defense, they need to feel empowered to communicate their concerns to those in charge.
Sometimes, however, it is the management that is actually responsible for committing the fraud. Business owners facing lots of red ink have been known to doctor the company books to create the appearance of prosperity. The goal: to keep the company afloat while finding needed financial resources.
Such cases are particularly challenging since employees may feel they can’t report the problem. That’s why it often makes sense to have the human resources department involved in fraud prevention programs. This approach sends the message that everyone – even management – is being held to the same ethical standards.
Kristopher K.L. Hebert, MSA, CPA is a manager in the real estate and commercial practice groups with a focus on forensic and litigation services at DiCicco, Gulman & Co. LLP, Woburn.
