There are many signs of fraud occurring within companies or with individuals. What are some of the signs we may see that indicate fraud is occurring? During a fraud investigation I am looking for signs that things are wrong. What clues may exist that things are not as they seem? Are there deceptions or misdirections that seem unusual that an honest person wouldn’t engage in? Are things set up in a way such that the environment is ripe for fraud to occur?
Apparent Control Weaknesses
When readily apparent major deficiencies in a company’s control procedures are identified, they should be considered warning signs that fraud could be occurring. All companies have some things that are not as secure as they should be. However, when the controls over a company’s assets and data are severely deficient, that is cause for alarm.
Some of the most common characteristics that might be considered severe deficiencies include:
Complete lack of segregation of critical duties, giving one or more people almost complete control over a financial area of a company and offering many opportunities to commit fraud and easily conceal it. For example, if the same person receives customer payments, records the payments to the customer’s accounts, makes the bank deposits, and reconciles the bank statement, there are many opportunities to commit and conceal fraud. The employee could steal a customer payment, record the payment on the customer’s account so the customer doesn’t know the funds have been stolen, and later adjust the accounting records while doing the bank reconciliation in order to cover the theft. If these duties were segregated among two or three employees, the risk of theft of a customer payment and subsequent acts to cover the theft are much less likely.
Ability to override controls and limits of authority easily, with either no oversight of the process or with lax enforcement of it. For example, an area supervisor regularly exceeds his authority for vendor payments. His approval limit is capped at $20,000. He commonly requests that vendors issue multiple invoices for work, so that no individual invoice exceeds the $20,000 threshold. Upper management is aware of this situation, but does not enforce the policy or regularly monitor this supervisor’s activities. By failing to enforce the policy, management may be effectively encouraging the employee to continue to break rules, which could create opportunities for fraud.
Failure to reconcile accounts regularly. Account reconciliation is important for accurate record keeping, even in the absence of fraud. Obviously, without reconciliations, management cannot know if the books and records are accurate. Failure to reconcile also can encourage theft by employees who are aware that reconciliations are not done, and a theft could go unnoticed for a long time.
Poor accounting records in general. This problem is often faced by smaller companies, but can also affect large companies, particularly ones that have done many acquisitions and have failed to integrate. Disjointed accounting systems make things difficult to monitor and reconcile, and offer opportunities for duplicate accounting entries to go unnoticed. Poor records also make it difficult for management to get an accurate financial picture of the company, and that could contribute to a fraud going unnoticed for a period of time.
It makes sense that the existence of major deficiencies in preventing fraud might be the precursor to fraud actually occurring at a company. If a company is lucky, it will catch the weaknesses before something happens. But many companies are not so lucky, and the identification of these types of problems should lead to further examination of the company to determine if, in fact, fraud may have occurred under these serious circumstances.
If a company is not diligent about implementing good control procedures over its accounting function, it’s also likely that management will not be interested in looking for the fraud that might result from the poor controls. Hopefully, internal or external fraud experts can encourage management to identify and examine the weaknesses and their results.
Another problem is that when serious problems are found, a company often either ignores the problems or fixes them without looking into whether a defalcation is associated with the control weaknesses. As difficult as it may be for management to admit that weaknesses like this may have lead to fraud, it is important to find out for sure what the fraud status is.
Lack of Information
When information and documentation is unavailable, it can raise questions about honesty or dishonesty. In the regular course of business, documents are sometimes lost or things cannot be explained. However, there comes a time when too many items are missing or the missing information is too suspicious to ignore.
For example, the bookkeeper of a non-profit organization frequently had difficulty locating canceled checks that were requested by the auditors as part of their annual financial statement audits. The auditors instead relied on the information on the carbon copies in conjunction with the general ledger detail. Unfortunately, the payees noted on the carbon copies were not accurate, and the checks in question were actually issued to the bookkeeper. She destroyed these canceled checks as soon as the bank statement arrived, and hoped that the auditors wouldn’t request copies of those specific checks.
When an occasional document is missing, it is usually not cause for alarm. But if a pattern of missing documentation emerges, it can be a warning sign of fraud. Look for missing information of a grouped or patterned nature: blocks of time, for a particular customer or vendor, for a certain type of transaction, or relating to a certain employee. A missing document or two is not all that disturbing, but ten missing documents, all related to one vendor—and all being questioned by management—are bothersome.
This is the fun stuff… When people seem to be going out of their way to conceal information, alter documentation, or otherwise engage in behavior designed to deceive those looking for facts (auditors, superiors, investigators, etc.), it raises suspicions about fraud.
For example, a disability insurance claimant fills out all paperwork, but does not mention her ownership interest in a business that is closely related to the job that she is currently unable to perform. A fraud investigator discovers the business ownership independently and becomes suspicious that the claimant may actually be working in this business, even though she claims she cannot work at her regular job due to disability. This ownership interest merits additional scrutiny. People often don’t hide things like this without good reason. It is possible that the claimant wanted to hide this ownership interest because it might lead to the investigator finding out she was working there. If she was not working there, and there was truly nothing to hide, why conceal it?
The same goes for deceptions in any type of fraud investigation or audit. It is presumed that if people are not honest about their involvement in situations, ownership of assets, professional licensing, or other material facts, they may have something to hide. Investigators should take clues like this very seriously. Lying is usually not compartmentalized. A deception in one area of life or a business is not usually an isolated incident. Take deception—either with outright lies or through the deliberate omission of critical information—as a likely sign of other problems.