Featured Article – 2007 January

An Inside Look at Occupational Fraud

An Inside Look At Occupational Fraud – Tip Sheet

Potential Warning Signs:

Poor Internal Controls:

More than any other factor, poor internal controls (a lack of segregation of duties) contribute to an environment where fraud can occur undetected.

Management’s Attitude and Actions:

Be wary of managers who are not candid and responsive. There may be something they don’t want you to know.

Quality of Financial Statements:

Be wary of financial statements not received on time or that do not include a signed outside auditor’s report.

Timeliness of Closings:

Today there are companies that can close their books in one day. Late reporting may simply be the result of sloppy bookkeeping but a continued inability to provide accurate, timely reports is a major warning sign.

Software Conversions:

Believe it or not, we have seen this used as an excuse in a number of instances as a cover for fraud. Simply put, software conversion times vary but typically a plan supported by management can be completed in a defined timeframe. A well-thought-out conversion will allow for legacy systems to run parallel with new systems – providing reliable and timely data until the new system is operational.

An Inside Look at Occupational Fraud
by Tom Beane

Occupational Fraud: ”The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.“

Occupational fraud is a widespread problem that affects virtually every organization, no matter what its industry, size or location. According to the Association of Certified Fraud Examiners (www.acfe.com), the typical U.S. organization loses 6 percent of its annual revenues to fraud. Based on the 2003 U.S. GDP, that adds up to about $660 billion in losses.

Insider fraud alone does not usually take a company down. However, our experience shows that as a company begins to experience significant difficulties, it becomes more likely that its management or employees may be tempted to act fraudulently to conceal problems in an attempt to save the company.

Those outside the day-to-day operations of a company may not be able to prevent fraud from occurring, but there are plenty of warning signs that may alert you to potential trouble. Heeding these suggestions may help you protect their interests and minimize losses

  • Look for indicators of the company’s business ethics. Check its Web site, its human resources manuals, its mission statement. Has the company taken a proactive approach to dealing with the possibility of fraud? Owners and management teams that use education, hotlines and surprise audits to increase the perception of detection are likely to experience fewer, and less costly, incidences of theft.
  • Monitor the responsiveness of the company’s management. Do they avoid or delay meetings with outside stakeholders? Do illnesses, vacations and schedule conflicts always seem to get in the way? Perhaps there’s something they want to hide.
  • Be wary of reporting red flags. A lack of timely financial information may be masking larger dangers.

Businesses can take significant steps to prevent fraud and, as with all cultural issues, it starts at the top. Top management must communicate to all managers that they are responsible for managing fraud risks within their areas of jurisdiction. Boards of directors and top management must establish processes for oversight of fraud risks.

Even with oversight in place, a report by the Association of Certified Fraud Examiners noted that three-quarters of the studied organizations victimized by fraud had external audit procedures at the time the fraud occurred, and more than half had internal audit procedures as well. Clearly, these procedures, while helpful, are not enough to prevent fraud. Interestingly, the Association did find that the tactic that had the greatest impact on minimizing losses was setting up anonymous fraud hotlines. Publicly owned companies subject to the Sarbanes-Oxley Act must have confidential reporting mechanisms in place; companies not subject to Sarbanes-Oxley would do well to set up such systems too. Finally, the Association found that confidential reporting procedures are even more effective when the reporting channel is open to customers, vendors and other third parties, in addition to employees.

The Best Defense
In our practice we have seen time and time again that companies that do not proactively approach fraud will experience significantly more instances of theft.

As logical as it seems that all companies should have strong ethics policies and procedures to minimize fraud, many do not. To prevent fraud, proactive owners and managers can increase detection through education, oversight, hotlines, surprise audits and overall ethical climates. For this reason, all stakeholders should assess the standards of the businesses with which they are involved and be alert to any changes in business practices.

For warning signs of fraud, see Tip Sheet.