The Association of Certified Fraud Examiners (ACFE) has been publishing studies every two years for the past 20 years to raise awareness of occupational fraud, and the role strong internal controls can play in limiting these schemes. The 2016 Report to the Nations on Occupational Fraud and Abuse covers more than 2,400 cases of white collar crime, occurring in more than 100 countries. About 1,000 of these cases involved U.S. organizations.
Findings in the latest report remain consistent from prior years. This shows, despite our best efforts to combat white collar crime, dishonest people continue to find novel ways, often exploiting technology, to steal from businesses and not-for-profit organizations.
The 2016 report estimates that the typical organization loses 5% of its revenues each year to fraud. Based on the latest Commerce Department estimate of 2015 U.S. gross domestic product ($17.9 trillion), U.S. organizations lost about $895 billion to fraud last year.
In other words, for every $1 million of revenues your business earned last year, a baseline estimate for how much you might have lost to occupational fraud is $50,000 (or 5% of $1 million) in the same period. Fraud happens to organizations of all sizes and in all types of industries, and that calculation can be sobering for many small business owners who think they’re immune to fraud.
The ACFE study exposes only the tip of the iceberg, however. Many frauds go undetected or unmeasured, and some losses are indirect, including lost productivity, reputational damage and the related future loss of business. Some organizations opt to cut their losses by simply terminating — but not fully prosecuting — white collar criminals because fraud investigations can also be costly. Many of these losses are never fully recovered.
The Fight against Fraud
A powerful deterrent of fraudulent behavior is the threat of being caught, because it eliminates the perceived opportunity for wrongdoing. But some detection methods are more effective and affordable than others. To get the most from your antifraud spending, consider these detection measures, which the ACFE’s study associated with the shortest durations and lowest losses:
- Account reconciliation,
- Internal audit,
- IT controls, and
Conversely, detection-by-chance — for example, through a notification by police — tends to reveal longer, more costly fraud schemes. Strong internal control systems may require significant time and money to implement, but they can be 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.
Unfortunately, the ACFE study reports that background checks aren’t 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.
This finding doesn’t necessarily mean that the company was the fraudster’s first victim, however. It’s possible that his or her attempts to steal from former employers went undetected. Or maybe the individual wasn’t prosecuted by a former employer to preserve the organization’s resources and reputation.
It is important to prosecute white collar criminals 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.
Small vs. Large Organizations
The median loss for all for-profit companies, regardless of whether they’re publicly traded or privately held, was roughly $180,000. By comparison, the median losses for government and not-for-profit entities were approximately $109,000 and $100,000, respectively.
The median loss for the largest organizations in the 2016 study was the same as the median loss for the smallest organizations ($150,000). But there are some subtle distinctions between the types of fraud schemes and the anti-fraud controls employed at small and large organizations.
Top 5 Fraud Schemes by Size
|Rank||< 100 Employees||100+ Employees|
|1||Corruption (29.9%)||Corruption (40.2%)|
|2||Billing (27.1%)||Billing (20.9%)|
|3||Check tampering (20.1%)||Non-cash schemes (19.3%)|
|4||Skimming (19.9%)||Expense reimbursement (13.9%)|
|5||Non-cash schemes (18.8%)||Cash on hand (10.3%)|
Globally, cash larceny, payroll, skimming, and check tampering (including the manipulation of payments made via both paper-based checks and electronic payment methods) schemes all occurred over twice as frequently in small businesses as in larger organizations.
Although corruption is listed as the top fraud scheme for both small and large organizations, it’s more common outside of North America than elsewhere around the globe. Corruption includes bribery, illegal gratuities and economic extortion. In the United States and Canada, billing schemes outnumber corruption schemes. Billing frauds were reported in 27.8% of the U.S. cases; corruption was reported in 24.9% of the U.S. cases.
Additionally, the 2016 study inquired about the types of antifraud controls fraud victims had implemented. The report revealed that larger organizations generally dedicate more resources toward deterring fraud.
Frequency of Antifraud Controls by Size
|Rank||< 100 Employees||100+ Employees|
|1||External financial statement audit (56.2%)||External financial statement audit (94.2%)|
|2||Code of conduct (53.8%)||Code of conduct (91.3%)|
|3||Management certification (43.2%)||Internal audit (88.3%)|
|4||Management review (40.4%)||Management certification (83.7%)|
|5||Internal audit (38.6%)||External audit of internal controls (79.9%)|
Fraudsters are caught differently by large and small organizations. Tips were the detection method in 29.6% of the cases involving small entities, compared to 43.5% of the cases involving large ones. This could result from the prevalence of reporting hotlines, which are more common among larger companies than small ones with limited resources.
Honest employees are an organization’s first line of defense against white collar crime. Here are some ways you can encourage employees to join in the fight against fraud:
Engage management in the fight. 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’s safe to commit fraud.
Invest in training. Educate staff on the red flags associated with fraud from within and outside the company. This helps detect and prevent fraud. It also sends a powerful message about your company’s intention 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 anyone inclined toward unethical behavior.
Set up a hotline. Anonymous fraud reporting hotlines can be an effective method of obtaining tips about unethical behaviors. Unfortunately, many small businesses shy away from this option, because they see it as 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 fraud it can help to uncover and the losses avoided.
The 2016 study found that employers were much more likely to be tipped off if they offer reporting hotlines. ACFE reports that tips led to the detection of fraud in 47% of the cases involving organizations with reporting hotlines, but only 28% of the cases involving organizations without hotlines.
The fact that more than half of all tips involved parties other than confirmed employees emphasizes the importance of cultivating tips from various sources. So it’s also advantageous to educate vendors, customers and owners on how to report suspicions of fraud.
Another interesting finding that’s new for 2016 is that more than half of complaints were submitted via the Internet. This suggests that companies with telephone-only reporting hotlines should consider adding more channels for reporting fraud.
Best Practices in Internal Controls
Dishonest people are given the opportunity to steal assets or cook the books if there are weak audit controls. In the 2016 study, a lack of internal controls and the ability to override internal controls were cited as the leading factors that contributed to fraud. Together, these factors were present in nearly half of the fraud cases in the latest study.
If you suspect fraud, your accounting and legal advisers can help reinforce your internal controls and investigate. Doing so can potentially save your company thousands, if not millions, of dollars in losses and put everyone on alert that fraud will not be tolerated and the consequences will be severe.