Featured Article – 2008 May

Vigilance, Proactive Steps Essential to Controlling Fraud

Vigilance, Proactive Steps Essential to Controlling Fraud
by Christopher H. Todd

When the economy heads south, the fraudsters start working overtime. There’s never a legitimate reason to steal from your employer, but when times get tough, more employees rationalize "good reasons" to engage in some bad behavior.

The Association of Certified Fraud Examiners estimates that 5 percent of all business revenue — about $652 billion — is lost to fraud each year. The median loss is $159,000, but one-fourth of the cases result in losses of at least $1 million.

In good times and bad, experience shows that a company’s higher-ups, the CEOs and the CFOs, are more likely than rank-and-file workers to be on the take.

A recent study by KPMG Forensics of 360 fraud cases it investigated in Europe, the Middle East and Africa found that nearly two-thirds of the perpetrators are in senior management. (Although the study did not include U.S. cases, it’s reasonable to expect similar percentages here.)

Several factors account for this pattern. First of all, top executives have the status and knowledge to work their way around the company’s financial controls. On a personal level, they may well get caught up in their own lavish lifestyle and lust for even more. Or, if things aren’t going well for the company, they may resort to adjusting financial statements in order to conceal losses that could be attributed to poor decisions they’ve made.

In assessing internal theft, the biggest difference between what’s taken by top-ranking fraudsters and those farther down the organization chart is the number of zeros at the end of the amount that’s unaccounted for.

In the fraud examinations I’ve conducted, I’ve often found that personal financial crises have transformed employees with good records into thieves. It might be a gambling problem, a missed mortgage payment, or, more common these days, high medical bills after a family member suffers a serious illness or injury.

Many times the internal thief is one who feels his company owes him something — perhaps he’s upset because he didn’t get an anticipated raise or promotion. Perpetrators typically start small and escalate their misdeeds for as long as it seems no one is on to their schemes. Sometimes it doesn’t end until the employee just stops coming in to work.

In fact, that KPMG study found that more than half the fraudsters conducted more than 20 frauds, and two-thirds of them escaped detection for one to five years.

Sometimes the fraud affects not only the employer but also its customers. In one recent case, a vice president for operations at a major bank took nearly $3 million from her employer and some 30 customers by stealing customer identity information, creating phony lines of credit and moving the money into her own accounts. The scam went on for four years before it was discovered.

In that case, the banker received an eight-year prison term, was ordered to repay her employer as well as pay more than $1 million in back taxes to the IRS.

Interestingly, however, many incidents of internal fraud never result in criminal charges against the perpetrator, and never come to the public’s attention. That’s because companies often decline to prosecute. They’d rather resolve the matter on their own, if possible, by recovering what they can and then dismissing the employee. The reason: if word gets out, the company suffers its own embarrassment for having a thief on its payroll. After all, the objective of any business is to make money, and publicizing its internal failings is not going to be part of its strategic plan.

The best way for businesses to prevent or control internal fraud is to take a proactive approach, creating an environment in which fraud is less likely to occur and establishing procedures that facilitate reporting suspected wrongdoing. Here are my key suggestions:

Establish strong internal controls. Emphasize separation of duties and internal controls. Cross-train a number of workers in handling finances, and never have the same person write the checks, make the deposits and reconcile the bank account.

Send a message from management. Establish a clear policy that sets high ethical standards — and make sure that top managers live that example.

Set up an anonymous tip line. Fraud hot lines are the most frequent sources of information that identifies fraudsters. A number of companies operate these lines as an independent third-party service.