2006 Ends: Another Year, Another Fraud

At the end of one year and the beginning of another, people seem fixated on changing for the better. Most people think up a resolution or two to get their new year started on a right foot. It seems the perfect time to make some positive changes.

Companies are no different, and the start of a year is the time when many things change. How many executives have fraud on their minds when starting a new year? Probably not many, and that’s too bad. The beginning of the year is typically a time when employees expect changes. Insurance policies are updated, new schedules may be implemented, and policies and procedures may change.

Why not focus on fraud prevention in the new year? Employees are ready for change and executives should take advantaged of that opportunity.

The one thing I can guarantee is that fraud will not go away this year, or any year in the future. Where there is an opportunity and a motive, there is a potential fraud. No matter how well people and companies protect their data and their assets, there will always be a way for a trusted and clever person to steal from her or his employer.

The Fraud Risks
Companies making anti-fraud improvements often focus overwhelmingly on the small-time frauds. They spend hours and dollars preventing theft by front-line employees who might be tempted to take inventory, equipment, customer payments, or other relatively small assets. While these types of fraud are the most common, in over 90 percent of fraud schemes, they are the least costly on a per-fraud basis.

Unfortunately, it seems that less focus is spent on the most expensive type of fraud: financial statement fraud. Financial statement fraud has the ability to put a company out of business in grand fashion, as we have seen with Enron and others. Although financial statement fraud is present in only about 10 percent of cases, the cost of each fraud can easily be in the millions or even billions of dollars.

The issue of financial statement fraud is wide-reaching, as it not only involves a deception of massive proportions committed by executives. It also touches investors and auditors, as it has the ability to create billions of dollars in stock losses and possibly even bring about the demise of an accounting firm. Yet executives have incentives to cheat, as performance bonuses, stock prices, and promotions may all be tied to the financial statements.

Individuals are at risk of fraud too, as they can easily become victims of scams such as identity theft, insurance fraud, credit card theft, and mortgage fraud. While the cost of each individual fraud is typically low, the aggregate cost of these schemes reaches into the millions and billions. These types of scams become particularly concerning when they involve the victimization of vulnerable groups of people, such as the elderly or lower income families.

Why Fraud Won’t Go Away
No matter what companies do, fraud will always be a part of business. Even at companies with strong fraud prevention controls, weaknesses exist. Where there are valuables, there may always be a tempted employee. No systems is completely foolproof, and accepting that fraud will always be an issue is the first step toward enhancing fraud prevention.

Market pressures and economic conditions can encourage fraud. Companies need to meet performance goals in order to meet investor expectations and comply with bank lending requirements. Businesses in all stages have incentives to cheat. The struggling business may want to paint a rosier picture of the company. The high-growth company may be inclined to manipulate numbers to keep up the appearance of growth.

Companies still have not done all they can to combat fraud internally. While Sarbanes-Oxley required some changes that enhanced corporate governance, it did not really require many proactive fraud prevention measures to be implemented. Therefore, the majority companies aren’t doing as much as they could or should to prevent fraud.

Even with an extreme focus on fraud over the last five years, companies are still vulnerable. Employees who are familiar with the systems have opportunities to commit fraud, and there may be few controls that will stop a high-ranking executive from manipulating numbers to her or his benefit. Fraud is here to stay.

Combatting Fraud
How do we as professionals and stakeholders see to it that companies become more vigilant in terms of preventing and detecting fraud? People with a vested interest in a fraud-free corporation need to demand better controls.

As professionals, we must take personal responsibility to help force a change for the better. Attorneys can become versed in corporate governance issues, and advise the board and executives about best practices. Accountants and auditors can play an active role in the assessment of fraud risks and development of policies and procedures.

Upper-level executives may play the most critical role in the implementation of anti-fraud best practices. Executives set the tone for the rest of the company. They must demonstrate a commitment to top-down improvements before the rest of the company will jump on the bandwagon.

While new systems and procedures may help to combat fraud in certain areas of a company, it is important for management to consider how it may also open new fraud doors. This is why the continuous monitoring of anti-fraud controls is important. Input from employees involved with the daily operations intertwined with these controls is critical. These employees see what management can’t see. They’ve got a close-up view of the controls and procedures in action.

Even if a company doesn’t have the budget or staff to implement a full-blown fraud prevention program, some basic steps can be taken to enhance the company’s fraud prevention efforts. This means making basic improvements to the most critical controls, improving the hiring and training process to create better employees, and communicating clear expectations about ethics to all employees.

All is not lost if the executives, attorneys, and auditors haven’t started planning to prevent fraud in the new year. The old saying “better late than never” is alive and well. Each and every step in the fraud prevention process is important, and companies should start heading in the right direction now to reduce fraud opportunities.

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