The red flags of fraud
Lessons learned from ACFE’s Report to the Nations
Among the various kinds of fraud that organizations might be faced with, occupational fraud is likely the largest and most prevalent threat. Occupational fraud—fraud committed against the organization by its own officers, directors, or employees—constitutes an attack against the organization from within, by the very people who were entrusted to protect its assets and resources. In this article, Koen Albers, vice president of Belgian chapter of the Association of Certified Fraud Examiners ACFE, discusses some highlights of the 2018 Report to the Nations.
Categories and Duration of Occupational Fraud
Survey participants estimated, based on their professional experience, that their organization loses 5 percent of their annual revenues
to fraud. Of the three primary categories of occupational fraud, asset misappropriations
are by far the most common, occurring in 89 percent of the cases in this study. However, they are also the least costly, causing a median loss of USD 114,000. Corruption schemes
are the next most common form of occupational fraud; 38 percent of the cases involved some form of corrupt act. These schemes resulted in a median loss to the victim organizations of USD 250,000. The least common and most costly form of occupational fraud is financial statement fraud
, which occurred in 10 percent of the cases and caused a median loss of USD 800,000.
The median duration
for all of the fraud cases in this study was 16 months
. However, the longer a fraud goes undetected, the larger the scheme will grow. Frauds that last over 60 months are more than 20 times as costly
as those that are caught in the first six months.
Initial Detection of Occupational Frauds
The leading detection methods are tips
, internal audit
, and management review
. These have been the three most common means of detecting occupational fraud in every edition of the report since 2010. Collectively, these three detection methods were cited in 68 percent of the cases in the current study. Tips were by far the most common means of detection at 40 percent of cases—more than internal audit (15 percent) and management review (13 percent) combined.
Anti-Fraud Controls at the Victim Organization
The presence of a robust system of anti-fraud controls can be a powerful deterrent, as well as a proactive prevention and detection mechanism, in the fight against fraud. Thus, organizations can benefit from knowing which anti-fraud controls are commonly used by their peers, as well as which tend to be the most effective.
The study concluded that 80 percent of the organizations had a code of conduct and underwent external financial statement audits, while 73 percent had internal audit departments, and 72 percent had company management certify the financial statements. On the other end of the spectrum, 19 percent of organizations had policies requiring job rotation or mandatory vacation, and only 12 percent provided rewards for whistleblowers.
However, when comparing the losses experienced by the victim organizations that had specific controls in place against the losses experienced by those that had not implemented such control, the study highlights that some controls are more effective than others. For example, the use of proactive data monitoring & analysis and surprise audits was associated with a more than 50 percent reduction, on average, in both the duration of fraud and the amount defrauded; making these two controls among the most useful tools in the fight against fraud.
The red flags of fraud
Understanding and recognizing the behavioral red flags
displayed by fraud perpetrators
can help organizations detect fraud and mitigate losses. The survey highlighted that 45 percent of fraud offenders had committed some form of non-fraud workplace misconduct
prior or during the time of the fraud, which indicates a link between occupational fraud and other forms of workplace misconduct such as bullying or intimidation and excessive absenteeism. In some circumstances, negative events surrounding a person’s conditions of employment
can cause financial stress or resentment toward the employer, which might play a role in the decision to commit fraud. The survey concluded that 39% of fraudsters had experienced some form of such event prior to, or during, the time of their frauds. The most common of these were negative performance evaluations and fear of job loss.
How do organizations react after a fraud has been discovered?
Not surprisingly, termination
was the most common disciplinary action taken in occupational fraud cases (65 percent). It is noteworthy that over one third
of perpetrators were not terminated as a direct result of committing fraud. In some cases the victim organization imposed lighter punishments
such as permitting the offender to resign (10 percent of cases) or placing him or her on probation (8 percent of cases), while in 6 percent of cases the fraudster received no punishment at all.After a fraud has been discovered and investigated, the case might proceed to prosecution, civil litigation, both, or neither. There are many factors that can affect this result, such as the amount of the financial loss, the strength of evidence, and prosecutorial discretion. The percent of cases that were referred to law enforcement decreased over time from 69 percent in 2008 to 58 percent in 2018 whilst the rate at which civil suits are filed has stayed consistent, ranging from 2nt percet to 24% within the same timeframe
The characteristics of the people who commit occupational fraud
There is a strong correlation between the fraud perpetrator’s level of authority and the size of the fraud. Fraud committed by owners/executives resulted in a median loss of USD 850,000, which was nearly six times larger than the median loss caused by managers, and 17 times larger than the median loss caused by low-level employees. High-level fraudsters tend to have greater access to an organization’s assets than low-level personnel. They may also have greater technical ability to commit and conceal fraud, and they might be able to use their authority to override or conceal their crimes in ways that low-level employees cannot.
The study also compared the frequency of various fraud schemes with the department where the occupational fraud took place. Corruption was by the most frequent fraud scheme in the Purchase department and with the Upper/Executive management. Cash on hand frauds were most often committed in the customer service department and checks or payment tampering occurred most often in the accounting department.
Approximately half of the cases in our study involved multiple perpetrators who colluded with one another to commit fraud. Fraud losses rose significantly when more than one fraudster was involved in a scheme. One likely explanation for this finding is that many anti-fraud controls work on the principles of separation of duties and independent checks. When multiple perpetrators conspire in a fraud scheme, they can circumvent the system of independent verification that might otherwise detect fraud.
About Koen Albers
Koen Albers is the current vice-president (and former president) of ACFE Belgium. He has worked as an internal auditor and fraud investigator in both private and public organizations. During his professional activities, Koen often used some of the resources and tools that the ACFE provides to its members or, in some cases, to nonmembers as well. See ACFE for a full overview of the available resources and tools. Besides the Report to the Nation, also the Fraud Prevention Check-up and the COSO Fraud Risk Management guide are very beneficial to an organization that wants to have a better control over its fraud risks. More information on training activities and events see ACFE Belgium.