Every two years, the Association of Certified Fraud Examiners (ACFE) publishes a study detailing the costs, schemes, perpetrators, and victims of occupational fraud. The 2014 edition of the Report to the Nations on Occupational Fraud and Abuse was recently released. It covers nearly 1,500 cases of white collar crime, occurring in more than 100 countries. Approximately 650 of these cases involved U.S. organizations.
The Cost of Fraud
Consistent with previous studies, the 2014 report estimates that the typical organization loses 5 percent of its revenues each year to fraud. Based on the latest Commerce Department estimate of 2013 U.S. gross domestic product ($16.8 trillion), domestic organizations lost about $840 billion to fraud last year.
However, the ACFE study exposes only the tip of the iceberg. Many frauds go undetected or unmeasured. Plus some losses are indirect, including lost productivity, reputational damage, and the related future loss of business. Fraud investigations can also be costly, so some organizations opt to cut their losses by simply terminating — but not prosecuting — white collar criminals.
In other words, the true losses from asset misappropriation, corruption, and financial statement fraud are probably much higher than the study suggests. Many of these losses are never fully recovered.
Set Yourself Up to Deter Fraud
The threat of being caught is a powerful deterrent of fraudulent behavior. But some detection methods are more effective than others. The following proactive detection methods revealed frauds with the shortest durations and lowest losses:
- Account reconciliation;
- IT controls;
- Internal audit; and
- Management review.
Conversely, detection-by-chance — for example, through a confession or notification by police — tends to reveal longer, more costly fraud schemes. The 2014 Report to the Nations concludes:
“Having adequate controls that seek out fraud, rather than relying on external or passive detection methods, can dramatically reduce the cost and duration of such schemes.”
Strong internal control systems may require significant time and money to implement, but they can represent resources well spent if fraud occurs at your organization.
A formal code of conduct is an example of a simple, but effective, internal control mechanism that any organization can implement to fight fraud. Although the vast majority of employees will never commit fraud, those who are tempted can be put off by a code of conduct that clearly outlines a zero-tolerance policy on unethical behaviors. It should contain clear illustrations and information about behavior that would violate the code, as well as instructions on how to confidentially report suspicious behavior that could be fraud.
Surprisingly, the ACFE study reports that background checks are not a particularly effective method of detecting fraud. That’s because most frauds are committed by individuals without a criminal record who have worked for their organizations for many years.
However, this finding doesn’t necessarily mean that the company was the fraudster’s first victim. It’s possible that his or her attempts to steal from former employers went undetected. Or perhaps the individual wasn’t prosecuted by a former employer to preserve the organization’s resources and reputation.
Prosecuting white collar criminals is important for several reasons. It helps recoup fraud losses, sets an example for other would-be fraudsters in your organization, and protects future employers from becoming the next fraud victim.
Look to Employees for Assistance
Honest employees are an organization’s first line of defense against white collar crime. Tips are the most common method of detecting fraud. Employees were the source of nearly half of those tips, according to the ACFE study.
Here are some ways you can encourage employees to join in the fight against fraud:
- Training – Educate staff on the red flags associated with fraud from within and outside the organization. This will help detect and prevent fraud. It will also send a powerful message that there is intention from the organizaiton to fight fraud no matter where it originates. Employees must perceive a high probability that fraudulent activity will be detected. The perception of detection is often sufficient enough to dissuade would be perpetrators.
- Management Engagement – Managers must be seen and heard reviewing controls and urgently correcting weaknesses that might be detected. If your organization’s managers are perceived to be unwilling or unable to take the time to review the controls, they may inadvertently be sending a message that it is safe to commit fraud.
- Hotline – Fraud reporting hotlines can be an effective method of obtaining tips about unethical behaviors. Unfortunately, many small businesses shy away from hotlines, because they think hotlines are too expensive and difficult to administer. A number of providers offer hotlines designed explicitly with small businesses in mind. The cost per employee is minimal in relation to the frauds it can help to uncover and prevent.
The 2014 Report to the Nations revealed that tips are the most common detection method for organizations with and without hotlines, and employers are much more likely to be tipped off if they offer reporting hotlines. The ACFE reports that tips led to the detection of fraud in 51 percent of the cases involving organizations with reporting hotlines, but only 33 percent in organizations without hotlines.
The fact that more than half of all tips involved parties other than employees emphasizes the importance of cultivating tips from various sources. So it is a good idea to educate vendors, customers, and owners on how to report suspicions of fraud.
Your accounting firm can help your organization implement and test internal controls and investigate if you suspect fraud. Doing so can potentially prevent your organization from significant losses and put everyone on alert that fraud will not be tolerated, and the consequences will be severe.