One of the most comprehensive fraud studies undertaken every two years is done by the Association of Certified Fraud Examiners (ACFE). The Report to the Nation on Occupational Fraud and Abuse was originally released in 1996, and there have been several updates including the current release.
As a bit of background, the ACFE is headquartered in Austin, Texas, and has over 37,000 members worldwide. About 80 percent of the members are in the United States, 10 percent are in Canada, and the remaining 10 percent are in 120 countries around the globe. The organization exists to provide antifraud training and certification.
The Certified Fraud Examiner (CFE) designation is the most-widely recognized, bona fide anti-fraud credential. It is obtained by successfully completing a rigorous application and testing process. Only about 30 percent of the organization’s members have obtained the CFE designation, and these members were surveyed for the study.
The Report to the Nation is based upon 1,134 frauds investigated by CFEs, and closely examines the types of fraud that occur, who commits the frauds, and the victim organizations. Each CFE completed an extensive questionnaire about a fraud she or he investigated, and the data was compiled by the ACFE.
An Environment for Fraud
Occupational fraud, also known as internal fraud or employee theft, occurs because employees are trusted. Businesses could not operate without employees who are trusted to carry out duties on behalf of the owners.
Employees become familiar with operations and may discover the gaps in the system. The more familiar they become with the business, the easier it will be to commit and conceal a fraud.
The workplace environment itself helps increase the incidence of fraud. Things like outsourcing and virtual offices have helped to decentralize companies and the level of supervision is naturally decreased. Reduced employee loyalty and insufficient controls over processes add to the risk of fraud.
The Fraud Schemes
Internal frauds fall into three categories: asset misappropriation, corruption and bribery, or financial statement fraud. It is not unusual for a fraud scheme to fall into more than one category, so you’ll see that the percentages below exceed 100 percent in total.
Asset misappropriations are the most common type of internal fraud, occurring in over 90 percent of fraud schemes. This crime deals with the theft of money or goods from the employer. Typical asset misappropriations include skimming cash, stealing inventory or equipment, payroll fraud, check tampering, and billing schemes. Any way you slice it, a scheme that directly gets money or assets out of a company falls into this category.
Corruption schemes include things like bribes, kickbacks from vendors who overcharge the company, and conflicts of interest. This type of fraud is present in over 30 percent of cases. Financial statement frauds occur far less often, in only about 10 percent of cases. These frauds are aimed at enhancing the financial statements, producing an indirect benefit such as a larger bonus, increased stock price, or higher profit sharing. Financial statement fraud includes things like overstating a company’s revenue or assets and understating the liabilities and expenses.
Although asset misappropriations occur most frequently, on average they cost companies the least. Asset misappropriations cause median losses of $150,000 per fraud. On the other hand, corruption schemes and financial statement frauds are much more costly per scheme. Corruption costs companies $538,000 per scheme, and financial statement fraud causes losses of $2 million each.
Access Equals Opportunity
The common thread in the characteristics of fraudsters is that the more access the perpetrator has, the more expensive the fraud is. As employees move up the career ladder, they are generally afforded more access to information, assets, and computer systems. Simply put, that access makes it easier to perpetrate. More importantly, it makes it easier to hide fraud by directly concealing information or by coercing lower level employees to do things to cover up the fraud.
The study looked at many of the characteristics of the fraudsters, including age, gender, and position within the company. It was found that men commit more frauds than women, with 61 percent of all frauds committed by males. The frauds men commit are also far more expensive, with a $250,000 median loss, compared to a $102,000 median loss in frauds committed by females. The cost of fraud also increases as the age of the perpetrator goes up.
The age and gender factors are believed to be secondary to the perpetrator’s position within a company. That is, older employees and male employees hold higher positions within an organization. Those positions offer them access to the opportunities to commit and conceal fraud, so the positions are really more important than the age and gender. This finding has been consistent with each successive Report to the Nation.
Another significant factor in internal frauds is the effect of collusion. When two or more employees collude to defraud the employer, the cost is increased significantly.
Frauds committed by groups of employees cost companies $485,000 each, while frauds committed by single perpetrators have a median cost of $100,000.
Generally speaking, the group frauds cost more because concealment by the group allows frauds to go on longer than those committed by a single person.
Preventing and Detecting Fraud
One of the most startling facts about perpetrators of internal fraud is that almost 88 percent had never been charged or convicted previously of a fraud-related offense. That means that companies are dealing with fraudsters who have been apparently honest in their prior employment. Companies are hiring employees who they believe are honest. How then, are they going to stop fraud if they don’t even know whom to suspect?
The fact that it is nearly impossible to predict who will commit fraud against an employer means that companies must actively prevent and detect fraud. They must use procedures aimed at stopping fraud and, at the very least, detecting fraud if it does occur.
Internal fraud is most commonly detected by tips from employees, customers, or vendors. The next most common way that occupational fraud is detected is by accident. Yes, that’s right. Running a close second is the accidental detection of fraud. This might mean a piece of mail that ends up on the wrong desk, a voicemail left in the wrong box, or some other innocent slip-up on the part of the fraudster.
Things like audits and internal controls were less likely to detect employee fraud than tips and accidents. Clearly if companies are relying on audits to catch fraud, they may have the wrong focus. In fact, companies in the study that had external audits actually had higher fraud losses than those with no external audits. It is also interesting to note that even though tips are the most common way to detect fraud, companies use hotlines less than other detection methods.
Companies clearly have a long way to go in reconciling what works with what they implement. The study shows that an increase in the availability of fraud hotlines and fraud awareness training could have a significant impact on the length and cost of internal fraud.
Certified Fraud Examiners estimate that companies lose 5 percent of their annual revenues to fraud. That amounts to $652 billion each year lost to internal fraud in the United States. Both the percentage and the dollar figure are staggering.
Consider your company or the businesses owned by your clients, and imagine what a theft equal to 5 percent of revenues would do to them. Theft by employees is essentially the theft of profits, and there are many companies that could not withstand such a loss.
Companies need to familiarize themselves with this study. It contains valuable information that can help them plot a strategy to prevent and detect internal fraud. At the very least, it will be an eye-opener to the realities of current day frauds.
The ACFE study can be found at http://www.acfe.com/documents/2006-rttn.pdf on the web.